If you are having difficulty managing your finances during a period of inflation despite having a steady income, you are most likely being underpaid. Since inflation has become a global problem that reduces the value of your money and declines your living standards, you need to know if your salary should respond to growing inflation.
Your salary should keep up with the rocketing inflation rates. Inflation escalates the cost of living, which means you should earn more to maintain your purchasing power. However, most employers do not factor inflation into salaries.
Let’s discuss how inflation directly affects your salary and how to calculate your pay growth based on inflation. This will allow you to understand contemporary economics better and confidently begin a pay rise negotiation with your employer.
Should my salary go up with inflation?
The world is witnessing an outpaced inflation rate, breaking the previous price hikes. For instance, the inflation rate in the UK was 10.7% in November 2022. The country’s inflation rate had never exceeded 5.4%, except in 1992, when it was 8.4%. With such soaring inflation rates, the country is in a serious cost of living crisis, ending three decades of price stability. The only way to ward off an in–work poverty is by asking for a salary increment to cushion the blow.
Whether you are earning more or less is subject to the rate of inflation prevailing in your country. If your salary increase is less than the inflation rate, every pound you earn will be less. It means you have to pay a major portion of your take-home salary to buy the same product, resulting in a lower standard of living. Conversely, if the inflation rate is less than your pay increase, each pound you earn will buy more. It shows that you have to consume a smaller portion of your income to buy the same product, increasing your living standards.
Inflation subsequently weakens your buying power. If you opt for a cheaper alternative in response to inflation, you will have to compromise your living standard. Therefore, the only way to escape poverty or maintain your quality of life is to get into pay rise negotiations. The goal is to buy the same product or service in the future without any burden. For that, your salary must grow with the soaring inflation rates.
What is inflation?
Inflation is a term quite regularly used in economics. It refers to the increase in prices over time. Politicians win elections with the promise of diminishing inflation, but most fail to do so. Developing countries are always a victim of high inflation, but the UK, with an ever-high inflation rate of 11.1% in October 2022, depicts that developed countries also suffer from cost escalations.
Inflation is an increase in the prices of products and services over a given time. Inflation can either be generally taken as an increased cost of living or also be specified for certain goods and services. Whatever the context, it represents how expensive a product or service has become in a certain amount of time, most commonly a year. The cost of living over time relative to the base year is termed the Consumer Price Index, and the increase in CPI over time refers to Consumer Price Inflation, which is the most common measure of inflation.
Economists say that when the money supply growth of a certain country outpaces its economic growth, the monetary authorities (central banks) try to manage the money supply and credit through inflation. Inflation aims to measure the impact of such price hikes on diversified products and services.
What should my annual pay rise be?
Salary offers financial security to workers. If your current salary does not grow with increasing inflation, you may no longer be able to sustain your life. Inflation decreases the value of every pound you earn. A survey has revealed that three-quarters of UK workers are considering a new job in response to the increasing cost of living and sky-rocketing inflation. If you were earning £75,000 last year and are earning the same now, you are making less money.
Therefore, it is imperative to match your salary rise to the current inflation rates. The calculator from the Office for National Statistics shows that if you are earning £100 per year, your annual pay rise should be £9 to keep up with the current inflation rate. You can also use it to determine the acceptable annual growth rate of your salary.
Alternatively, you can use salary checkers, such as Totaljobs, Reed, and Indeed, which are equipped with online tools to help you find the average salary in your sector. However, the average pay rise differs with the region, industry type, and pay grade. A general rule states that a 3% pay rise is quite suitable, but it does not mean you should not ask for a further increment. If you think you are being underpaid, it is time to begin a pay rise negotiation because inflation is a strong reason, rather than an excuse, to add a few pounds to your salary bucket.
How to calculate pay increases based on inflation?
Recent research by Fidelity International has revealed that only 50% of men and 37% of women have ever asked for a pay rise. However, the current inflation trends have stirred the global market, and more people are expected to join this squad, asking for a pay rise. A sustained pay rise will definitely ward off the aftermath of inflation, but how to calculate what pay growth will maintain your purchasing power in the future?
The most common method to calculate your salary increase is by Consumer Price Index. Find the inflation percentage for the previous year. Afterwards, multiply your salary by that percentage to get your salary increase. If your current salary is £75,000 and CPI has increased by 2.5%, your salary rise would be £1,875. (75,000 х 0.025).
Another effective way to calculate your salary based on inflation is a Cost-of-Living Adjustment. COLA is commonly used to adjust pension benefits and social security to keep up with the escalated cost of living. To calculate salary increase through this method, multiply the COLA percentage by your current salary; if you currently earn £75,000, and the COLA percentage is 2%, your salary increase would be £1500 (£75,000 x 0.02).
Simply, you can use a verified pay rise calculator by inserting your weekly, monthly, or annual salary and get an estimated pay rise to match inflation. By calculating your pay increase based on inflation rates, you will get to know whether you are getting the minimum wage growth or a generous one.
Should my salary increase due to the cost of living crisis?
Inflation increases the cost of regular living expenditures. If the price of everyday items, such as food, clothing, housing, fuel, etc., increases, employees need more money to purchase such items. In other words, inflation squeezes the household income, declining the buying power of consumers. Therefore, adjusting the cost of living with your salary is essential to ensure a sustained financial situation.
Your salary must increase with an escalated cost of living so you can effortlessly afford your living expenses. According to a survey, almost half of UK employees want a monthly cost of living salary boost to keep up with soaring inflation rates. Therefore, employers should consider the cost-of-living pay adjustments to provide financial ease to their employees.
Read my article below on what the average salary is for a 30-year-old in the UK and how this is impacted by inflation.
What is the average salary for a 30-year-old in the UK?
Why do salaries not keep up with inflation?
Despite the intensifying cost of living crisis, pay rise is still falling behind in most parts of the world. The average pay rise in the public sector was 6.4% between September 2022 to October 2022, and that of the private sector was 7.2%. According to a survey by Aspire, nearly half of the candidates have been waiting for a pay rise for more than a year.
Employers are well-aware of inflation uncertainty. As salaries tend to move upward, companies are slow to raise salaries before assessing the long-term trends of inflation. If inflation is short-term and the market deteriorates, it is extremely difficult to reduce workers’ wages. Companies have to be very vigilant when it comes to managing their finances of the company. Therefore companies do not abruptly respond to inflation.
Inflation drastically reduces the value of your money. This might weaken your purchasing power and negatively impact your future financial security. After all, most people opt for jobs over starting their own businesses because of the stability they offer. Therefore, your salary should be in-line with soaring inflation rates to maintain a decent standard of living.
Employees can use inflation to enter into pay rise negotiations, but before that, they should know how much the pay rise will be enough to sustain inflation in the long run. Moreover, they must also realise that most companies do not opt for abrupt decisions while deciding on salary budgets to ward off the drawbacks of deflation.
As always, please remember I am an Accountant, but not your Accountant. In this post (and all of my others) I share information and oftentimes give anecdotes about what has worked well for me. However, I do not know your personal financial situation and so do not offer individual financial advice. If you are unsure of a particular financial subject, please hire a qualified financial advisor to guide you.
This article has been written by Luke Girling, ACA – a qualified Accountant and personal finance enthusiast in the UK. Please visit my ‘About‘ page for more information. To verify my ACA credentials – please search for my name at the ICAEW member finder. To get in touch with questions or ideas for future posts, please comment below or contact me here.