Why your pay rise is less than inflation this year

Here's how the wage-price spiral impacts the cost of living and your pay packet and why the RBA desperately tries to keep it from happening.

Did you get an underwhelming pay rise this year? Or maybe you missed out on a raise altogether.

You might have heard the term wage-price spiral thrown around a bit lately. With inflation climbing in Australia, it's something the Reserve Bank of Australia (RBA) really wants to avoid. But what does it mean and does it even impact you? Spoiler: it does.

The wage-price spiral describes a situation of rising employee wages leading to rising prices for goods and services, which then leads to rising wages once again.

What happens in a wage-price spiral?

Let's say it begins with employee wages going up. Because people now have more disposable income, everyone starts to spend more money on products and services and perhaps buy some big-ticket items they've been holding off on.

With everyone out there shopping, there's increased demand for products and services. As well as increased demand, employers have higher costs in the form of higher wages for staff. As a result of these 2 factors, companies lift their prices for their products and services.

Increased prices for goods and services cause inflation to go up as people need to spend more money on everyday items than they previously had to. This leads to workers negotiating pay rises to keep up with the cost of living and prevent their money from going backwards.

Now, start at the beginning again and you've got yourself a wage-price spiral.

How it impacts the cost of living and your pay packet

To break the wage-price spiral, either employee wages or prices of goods and services need to stop rising. Unfortunately for employees, it is usually easier to stop wages from rising in the first instance.

This is exactly what's happening right now.

Australia's inflation rate as of September 2022 is 6.10%. Because of this, you might be trying to negotiate a pay rise of at least 6.10% with your boss this year. After all, it seems only fair that your money keeps up with the cost of living, right?

However, the RBA is advocating for pay rises like this not to happen. Why? Because it's trying to avoid a wage-price spiral.

"If wage increases become common in the 4–5% range, then it is going to be harder to return inflation to 2.5%," said RBA governor Philip Lowe.

"3.5% is kind of the anchoring point that I want people to keep in mind and I know it's difficult when inflation is higher than that," he added.

The RBA has been aggressively lifting the cash rate this year to try to reduce consumer spending and curb inflation. If we all got pay rises of 6.10% to match inflation, the RBA fears this wouldn't do anything to discourage spending and stop inflation. It would need to continue increasing the cash rate.

Even if you don't have a mortgage, a higher cash rate could still impact you. As companies also have higher costs, they'd be forced to lay people off and we'd see unemployment rates go up.

What should you do about it?

Unfortunately, as we try to avoid a wage-price spiral, it means the cost of living will remain high for a bit longer and wages are likely to remain quite flat. That's not to say you shouldn't ask for a pay rise (you definitely should). It just means you might have a tougher time negotiating for one this year.

In the meantime, here are a few things you can do to cope with the increased cost of living:

• Refinance your home loan
• Switch energy providers
• Look for creative ways to cut back and save
• Increase your income with freelance or casual work
• Switch to a high interest savings account with a better rate