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The Inflation Adjustment Factor for 2008-09 Wages Virtually Zero

POV 01.22.2009

Introduction

One of the more difficult decisions facing financial executives and their boards of directors is wage determination for employees.  It is essential that bank employees be paid properly in order to attract, retain and motivate.  The annual wage adjustment process impacts not only the morale and motivation of the staff, but also profitability and ultimately returns to shareholders.  What method should executives use to determine the proper wage and salary adjustment for the upcoming year?

The Components of Wage Adjustment

Traditionally, wage adjustment decisions should include consideration of inflation, employee productivity, local wage conditions, profitability, and any past inequities due to extraordinary circumstances.  Of all these factors, the impact of inflation on real wages often provides a major challenge.

Normally, inflation tends to be evenly divided between months, and it matters little what 12-month period is selected to calculate the cost of living adjustment. The 12-month period varies from institution to institution, but once it has been selected that period should be used continuously. However, it is not unusual for employers to change the period.  Many companies choose the 12-months ending September 30 as the base period, because the end of the third quarter is the traditional time for creating annual budgets, including wage and salary levels, for the upcoming year.  Others prefer to wait until the entire calendar year data is available.  Because of rapidly changing energy prices, the difference between the last twelve months inflation impact September, 2008 versus December, 2008 is astounding.

Media Attention to Summer Gas Hyperinflation Created False Impressions

During the summer months when gasoline prices virtually doubled, media attention created a sense that real wages were being permanently destroyed and that employees would have to receive substantial wage increases in 2009 to compensate for the summer losses.  As it turns out, while the real wage losses of the summer were real and widely reported, the real wage gains from energy deflation of the last months of 2008 were also substantial, but widely underreported. 

LTM (Last 12 Months) Inflation for 2008 Now Official

The Bureau of Labor Statistics (BLS) recently released a report on inflation for the entire year of 2008.  The report indicates that The Consumer Price Index for All Urban Consumers (CPI-U) decreased 1.0 percent in December 2008, before seasonal adjustment. The December CPI 2008 level of 210.228 (1982-84=100) was only 0.1 percent higher than in December 2007.  The BLS noted that the 0.1 percent change was the smallest calendar year increase since a 0.7 percent decline in 1954 and compares with a 4.1 percent increase for the 12 months ended December 2007.

In other words, while your employees undoubtedly suffered substantial wage erosion during this past summer’s hyperinflation of energy, the recent deflationary period of energy has boosted real earning to the point that all things considered, the impact on real wages for the entire year of 2008 is virtually zero.  This change has been rapid.  For example, at the end of July 2008, the LTM inflation rate stood at 5.6%, dropped to 4.9% by September, 1.1% in November, and a paltry 0.1% by December of 2008.  It is interesting to note that LTM core inflation rates (All CPI items minus food and energy) were much more stable at 2.5%, 2.5%, and 2.0% for July, September and November respectively, ending the year in December at 1.8%.

Conclusion

Strong media attention during the energy hyperinflation of the summer months has led many to the inaccurate conclusion that real earnings in 2008 have dropped substantially.  In fact, price levels have been falling during the last few months of 2008 and the net effect has left real wages virtually unchanged.  It is an important message to share with your staff.