You got a 3% raise and felt good about it. Then you notice that prices rose 4%. Did you win or lose? The answer is that your pay went up in numbers but fell in what it can buy. The difference between those two is the difference between nominal and real income.

Nominal vs Real

Nominal pay is the number on your payslip. Real pay is what that number can buy after adjusting for price changes. The formula is:

Real change = (1 + raise) ÷ (1 + inflation) − 1.

With a 3% raise and 4% inflation, real change = 1.03 ÷ 1.04 − 1 = −0.96%. Your pay buys about 1% less than it did a year ago. You have taken a small pay cut, even though the number went up. A common shortcut is to subtract inflation from the raise (3 − 4 = −1), which works well for small numbers.

Real Raises Compound, Too

One year of falling behind looks small. Over time, it adds up. If you receive 3% raises for five years and inflation averages 4%, your purchasing power changes by (1.03 ÷ 1.04)^5 − 1 = −4.7%. On a 50,000 salary, that is the equivalent of losing around 2,350 of buying power a year by year five.

Now reverse it. If your raise is 5% and inflation is 3%, your real raise is 1.05 ÷ 1.03 − 1 = about 1.9% a year, which compounds into roughly 10% more purchasing power in five years. See our guide to inflation and your savings for the same idea applied to money in the bank.

What Raise Do You Need to Break Even?

To keep your buying power, your raise must at least match inflation. To work out the exact figure: required raise = inflation. Beyond that, a raise only counts as progress if it exceeds inflation. If inflation is 4% and you want a 2% real raise, you need about 1.04 × 1.02 − 1 = 6.1%.

Which Inflation Number to Use?

Official inflation is an average for a basket of goods, and your personal inflation may be very different. If most of your spending goes on rent, food and fuel, and those rise faster than the average, your real raise is smaller than the headline number suggests. Check what changed in your own bills over the last year and compare it with the official figure.

Using the Numbers to Negotiate

  • Find the inflation rate for your country over the past 12 months from your national statistics office.
  • Calculate how much your pay is worth in real terms compared with when your last raise took effect.
  • Collect evidence of your performance and market rates for your role.
  • Ask for a raise that restores your buying power plus an increase that reflects your contribution.

An employer is more likely to respond to a clear calculation than to a general complaint that prices are rising.

Non-Salary Items to Consider

Raises are not the only way pay can change. Bonuses, pension contributions, healthcare, extra leave and flexible working all have value. A small salary increase with a better pension match may beat a larger one without it. Our article on gross versus net pay explains how tax affects what you keep from each raise.

Savings and Debt

Inflation also affects your savings and your debts. Cash savings lose value if they earn less than inflation, while fixed-rate debt becomes easier to repay in real terms if your income keeps up. Be careful with this idea, because the effect only helps if your income actually rises.

Put It Into Practice

Take your last raise, subtract the inflation rate over the same period, and see whether you are ahead. Then use our Inflation calculator to see what a given amount of money would be worth in the future or the past.