How Does CPI Relate to Wage Increases?

The Consumer Price Index (CPI) measures how much average prices are moving by surveying households to find their average spend on specific goods and services during a given time period and then comparing that total cost to previous time periods.

The group of goods measured by the CPI is called the market basket of goods and services. Generally speaking, the goods and services basket includes the most commonly purchased items for households across the U.S., such as housing expenses, groceries, transportation expenses, clothes, education expenses, health care, and more.

CPI is used in decision making by the government and private organizations alike. It can serve as a good economic indicator showing where our prices are going, and can also be used to measure how much a dollar of income will purchase—changes that show whether there is an increase or decrease in purchasing power with the same amount of money. In other words, it’s a common way to measure inflation since it objectively measures increases in the cost of consumer goods and services.

Some people also equate CPI with a cost-of-living measurement. While it is quite similar, CPI does not take all of the same factors into account. A true cost-of-living measurement would include other factors that affect an individual’s ability to afford the products, as well as other changes that affect quality of life. Nonetheless, CPI can be an acceptable proxy for cost-of-living changes in many applications, such as wage increases.

(Note: There are multiple CPI measurements made by the Bureau of Labor Statistics that vary in terms of which consumers are represented, but we’ll be discussing CPI in broad, generic terms.)

How Does CPI Relate to Wage Increases?

CPI can relate both directly and indirectly to wage increases, depending in part on your company policies. For example:

• If you generally try to base wage increases on increases in costs of living, CPI may be one gauge utilized to determine how much an individual’s cost of living has gone up in the course of a year. In this way, the change in CPI can be directly tied to the change in wages that an employer offers when making cost-of-living wage adjustments.
• CPI can also be used when determining differences in costs between different geographic locations. However, as noted above, it probably should not be the only consideration.
• CPI may also be specifically noted as the benchmark in wage escalation clauses, such as those often found in collective bargaining agreements.
• There is a direct correlation between annual CPI changes and changes to some types of fixed income, such as Social Security income and other government-sponsored programs.
• CPI can relate to wage increases indirectly because as the costs of goods go up, the wages required for new hires will also go up, regardless of whether an organization has already raised wages for existing employees. In other words, prospective recruits will most likely be more selective in what wage rate they are willing to accept. Individuals may become more sensitive to wage or raise levels if the costs of goods are increasing faster than wages.

Using CPI to Raise Wages: Some Tips

If you’re going to use CPI as the basis for a cost-of-living wage adjustment, be sure to:

• Specify which CPI you’ll be using—there are separate CPI calculations for major cities and regions. There are also national CPI measurements.
• Specify the benchmark date so that you have a point of comparison. Be sure to understand that the CPI measurement is taken at different intervals, depending on the region you’re referencing.
• Consider, if you’re comparing year-to-year, whether you’ll use the annual average CPI change or whether you’ll compare a specific month to that same month in the previous year. For example, will you compare the 2015 average to the 2014 average, or will you compare December 2015 CPI to December 2014 CPI for your chosen city or region? There can be a difference in the outcome—be careful!
• Consider whether you need a policy to cover situations in which the CPI change is greater than your budgetary adjustments will allow. You may have to include a maximum annual adjustment level.
• Consider whether you will set a minimum annual wage adjustment, even if the change in CPI is less than that amount.

Does your organization give annual cost-of-living wage adjustments? What do you use as a benchmark for these changes?

This article does not constitute legal advice. Always consult legal counsel with specific questions.
 

About Bridget Miller:

Bridget Miller is a business consultant with a specialized MBA in International Economics and Management, which provides a unique perspective on business challenges. She’s been working in the corporate world for over 15 years, with experience across multiple diverse departments including HR, sales, marketing, IT, commercial development, and training.