If annual salary increase percentages are less than inflation doesn't that mean that each year is financially tougher than the last?

  • besides general application to economics as a principle, and yes it is true, how is this directly related to personal finance in your case? this site is for asking what is relevant to you personally in relation to money. Aug 3 '17 at 21:41
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    I am just trying to understand the financial world.
    – xvk3
    Aug 3 '17 at 21:42
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    Broadly yes, but: inflation is calculated after the fact where wage increase is given before the payouts, and wage increases are part of the input into the calculated inflation statistic.
    – user662852
    Aug 4 '17 at 2:50
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    Even if your salary increase matches the rate of inflation, each year will be financially tougher. This is partly because the measurement of inflation takes note of improvements in products, but the older less good products may no longer be available to buy at a lower price, and partly because new products and services will come along that you want to buy, e.g. smartphones, streaming TV services.
    – Mike Scott
    Aug 4 '17 at 5:35

Inflation is a macro pressure. It is not experienced at a micro level on a 1 to 1 basis.

In a given year a pay raise less than the stated CPI rate, for some people the change will either

  • be a real pay decrease, or
  • make no difference, or
  • be a real pay increase

Over a long time if that trend continues, spread over a large number of people, on average, it will be a real pay decrease.

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    for example, inflation might include the price of cars, furniture, or houses, which you might not buy in a given year or even decade. If those items were rising much faster (or slower) than groceries, transit, clothing, electricity, and so on, your actual cost of living change could be very different from inflation. That said, it's more normal for pretty much everything you buy to increase at roughly the same rate. Aug 3 '17 at 21:48
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    @KateGregory, it is absolutely not normal for everything you buy to increase at the same rate. It's not even true that everything you buy will cost more from year to year on nominal dollar terms. Over a long period of time, spread over the entire economy, the purchasing power of a dollar deteriorates. How each single person feels that deterioration specifically in a single year will differ. If a person moves from Manhattan New York to Madison Wisconsin it's likely the purchasing power of the cash in their wallet will have gone up.
    – quid
    Aug 3 '17 at 22:25
  • let's leave geography out of it for now. If groceries go up 5% in a year, usually clothes, furniture, and cars do too. Sometimes one thing (eg oil, corn) spikes up, but over time it tends to drag everything up, because the furniture makers and car manufacturers all buy whatever spiked, or employ people who buy it and are demanding higher salaries. Or they can't afford the higher price of the spiked thing and it goes back down. So the same like 5.01 vs 4.99, no. But the same like "everything went up between 4.5 and 5.5" - pretty normal. Aug 3 '17 at 22:39
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    It's a macro concept. You can't leave parts out of it because you want to apply it in a micro manner. Over a long time, spread over a large number of people, spread over the entire economy, the purchasing power of a dollar deteriorates; that's inflation. It does not 1:1 apply to every individual person or item in the consumer basket; so no, it would be completely abnormal for every individual item in the consumer basket to experience the same rate of price change at the same time. Will an individual consumer's consumer basket change in a year, sure; will that match the CPI rate, maybe not.
    – quid
    Aug 3 '17 at 23:32
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    @WillV On. A. 1. To. 1. Basis. Not, "the entire concept of inflation is not felt at a micro level". I did not say or insinuate that inflation is not felt in any way at the micro level, I said effect will be felt at a rate that will likely differ from the published inflation rates; because those are macro measures. Just as with any average the constituent members that comprise the average will not all equal the average. Most of my answer addresses the micro impact of inflation obviously indicating that inflation is felt to some extent at the micro level.
    – quid
    Aug 4 '17 at 5:46

Short answer: YES

A 20% annual inflation rate means current goods and services will be more expensive by 20% next year. If your incremental salary annual raise is less than 20%, let say, 10%, then you are beaten (20% - 10% = 10%) by inflation. This means current goods and service will be more expensive for you by 10% next year.

Here is the illustration :

  1. Suppose you would buy a car next year, current price is $1.000
  2. You have $1.000 salary, and you are able to buy a car right now
  3. Let set Inflation rate 20% and your salary increase 10% every year
  4. Jump to next year, the car now priced at $1.200 and your salary is $1.100
  5. Now you can't buy a car, so you are financially tougher
  • I like this answer it explains the concept in a clear way! +1
    – xvk3
    Aug 4 '17 at 7:50
  • However, note that inflation is an average of price increases that have already occurred in a sample of real prices. The prices of some items might have increased less than the overall inflation rate, some more. The inflation rate does not dictate that sellers raise their prices to match.
    – chepner
    Aug 4 '17 at 12:25
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    This answer is dead wrong. First, not every good sees the same price increases; inflation is an aggregate over some representative basket of goods. Second not everybody buys the exact basket of goods used in the calculation, so each household experiences inflation slightly differently. Third, some goods in the basket aren't actually consumed by anybody, e.g. "owners' equivalent rent" and are therefore won't really be felt by individual households. (See newyorkfed.org/medialibrary/media/research/staff_reports/… for an explanation of OER.)
    – Nobody
    Aug 4 '17 at 16:47

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