Inflation is soaring. So where’s my pay raise?

When consumer prices began soaring last year, a trade union representing staff at the European Central Bank (ECB) demanded their wages increase in lockstep with inflation.
This grassroots effort to index pay to price increases was ultimately unsuccessful, but it was incendiary stuff coming from the supposed guardians of euro-area price stability. Indexation, after all, can determine who is shielded from inflation — and who suffers from it.
From the ECB’s perspective, it’s fortunate that the practice of linking wage raises to the inflation rate is less common now in Europe than it was in the 1970s. Inflation is increasing at an annual rate of 7.4%, and the bank is desperate to avoid a spiral whereby higher consumer prices beget higher wages, which further lift the price of goods and services.
Not indexing wages to rising prices makes those dreaded second-round inflation effects less likely — but the cost is borne by workers whose purchasing power gets diminished.
The longer inflation persists, though, the greater pressure there will be to incorporate cost-of-living adjustments in pay. Asking people to simply forgo big salary increases, as Bank of England governor Andrew Bailey rather insensitively did in February, won’t cut it. Workers right now also have some leverage: Eurozone unemployment is at historic lows, and organised labour retains a strong voice on this side of the Atlantic. This week, an influential trade union representing German steel employees demanded an 8.2% pay increase.
Workers have reason to feel short-changed, too. Indexation is widely used in the economy to protect the real value of payments. Companies, for example, frequently insist on indexation clauses, allowing them to pass on raw material price increases and other costs to clients. Regulated utilities, telecoms companies and commercial real estate providers are particularly skilled at this. No wonder corporate profits are still going gangbusters.
State pensions are also fairly well protected from inflation. Almost all euro-area public pension plans are fully or partially indexed, as is US Social Security, which rose by 5.9% in 2022, the largest bump in 40 years.
Pensioners can still experience a real income squeeze due to the time lag between when prices rise and when benefits payments go up. That’s why French President Emmanuel Macron promised retirees their pensions would be re-indexed from the summer instead of from January. In contrast, UK state pensions this month rose by just 3.1%, the inflation rate that applied last fall, which is less than half the now prevailing rate of price increases.
Indexation also has an important role in taxation, normally to prevent workers from being penalized when nominal wages rise. Boris Johnson’s government, however, last year froze indexation of key income taxation thresholds until 2026. That means rising nominal wages will cause more UK earners to fall into a higher tax bracket, exacerbating the cost-of-living squeeze.

—Bloomberg