“The first rule of economics is scarcity. The first rule of politics is to ignore the first rule of economics.”
Which is the classic and best understood definition of inflation:
- The description of how big a fish that you caught the last time you were out
- What it takes to make your exercise bike into a real bike
- Too many dollars chasing too few goods and services
So yes, there could also have been answer D) All of the above, but let’s focus on answer C.
Lately amongst all the climate change, vaccine, pipeline blackmail, Middle East sparring and immigration crisis headlines, one stood out to me that I haven’t been beaten over the head with by the mainstream media for years – inflation is increasing. We shouldn’t be too surprised. We have pent-up demand (lockdowns, closures, restrictions) fairly widespread across most states. We’ve increased the money supply. (Wage increases haven’t really slowed down, unemployment benefit payments exceed real paying job opportunities, and the federal government keeps sending stimulus checks). Minimum wage laws continue to advance, generally in larger populated cities. So yes, we have inflation – too many dollars chasing too few goods and services. Results from April 2021 indicate a 4.6% annualized rate. As the economy re-opens, people travel and take vacations, eat out more, just about everything we’ve been missing out on suddenly becomes wanted – and here we are with money to spend on it.
How It Works
“Expert government officials” believe this is just a temporary blip, and the economic recovery will continue at a managed pace. And if that happens to be off the mark, they can always increase interest rates or use other monetary policy rules to slow the inflationary spiral. OK, now I feel like I’m getting too far away from the reason I’m writing this, which is to think through your 2021 merit budget.
I like graphs and charts that tell a story. I found the one below on-line, it’s from the St. Louis Federal Reserve Bank. It charts the inflation rate and associated wage growth by month during two specific periods, January 1960 through June 2009, and July 2009 through September 2015.
It isn’t hard to see that once inflation starts to break away from around 3%, wage growth starts to accelerate as well. Other non-government officials call this the “Wage-Inflation Spiral.” It is a bit of a chicken-or-egg theory IMO, but the basic thought is this. When wages increase, disposable income increases, which increases demand for goods and services, causing prices to rise. Rising prices increase demand for higher wages, and the cycle continues.
What This Means For You
If you’ve already set your 2021 merit budget around 3%, don’t panic. It’s still early days to be predicting whether or not our economy starts a roller coaster ride. But you might at least be thinking about how increasing inflation effects your compensation program. Here are some things to consider.
- Talk to your CFO about worst case scenario. Might you need an off-cycle fund, in addition to your approved budget, in order to make special adjustments for key talent?
- Speaking of key talent, can you better differentiate rewards than you have been? Start to think through eliminating or at least reducing where the Big E (entitlement) has found a home under your pay-for-performance good intentions.
- Consider being a little more aggressive in adjusting your pay ranges this year. Most companies use either a “lead-lag” or a “lag” approach to setting pay ranges to the pay strategy. It probably couldn’t hurt to increase that estimate of what other companies are going to do, plus if you’re wrong, you can easily adjust for it in 2022. But if you start to fall behind on adjusting your pay ranges, it can have a serious effect on your ability to attract talent.
- If your organization needs to raise prices (thus changing the financial plan) does that ripple through into the company bonus plan or sales incentive plans? Do you already have a provision for adjustments of quotas and metrics?
What Will Employees Think?
If inflation does move up appreciably this year, you are sure to hear, “this merit increase doesn’t even cover the cost-of-living.” Remember, cost-of-labor should be the driver of benchmarking your cash compensation programs, not cost-of-living. That said, it is always top of mind with your employees, and it looks like it could be for you this year as well.
Jim Harvey is a Managing Partner with Alliance Compensation LLC (www.alliancecompensation.com), a team of seasoned experts and a trusted solution for clients across the Western US in public and private companies. He has over 35 years of experience in corporate leadership roles and consulting, and lives with his wife and three dogs in Sherwood, OR.