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December 13, 2017

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Deflation, Inflation and Compensation

The Possibility of Deflation

Unless you are in Japan, no one in your management team or workforce has experience with deflation. In fact, the senior management team is probably still influenced by their formative years in the seventies when inflation hit double digits. Yet over the past few years, economists have been debating the possibility of deflation. This is a situation that most firms will be poorly equipped to respond to.

It's good policy never to believe economists. However, compensation managers should have a plan for what to do if we do hit a deflationary period.

What it Means to Compensation

In a deflationary environment prices fall, this will create pressure to reduce salaries. Our compensation systems, and the psychology of the workforce, are totally unprepared for this.

I should add I'm pretty much unprepared for this as well. The only solution I can think of is to build more variable comp into the package so that one has a cushion to reduce total comp if deflation hits. There may be other answers but nothing else comes to mind. I dread to think of asking a workforce to take a 10% salary cut because deflation has priced them out of the market.

What it Means to Employees

The psychological aspects of deflation will be another important issue for HR. As Hamish McRae of The Independent points out, people will think very differently about their mortgage if they believe that 20 years from now their house will only be worth two thirds its current value. Deflation is not all bad. Saving for retirement is easier if everything will cost less when you finally reach retirement age.

If we hit deflationary times then HR must help employees come to terms with what this means to their financial future. The good and the bad will need to be sorted out in people's minds and in their financial strategies. This will require a significant education program.

On the Other Hand

Some powerful forces in the U.S. are committed to engaging in a long series of wars. If Vietnam is any guide, this will lead to high inflation. So while U.S. firms are thinking about deflation, they may well end up facing just the opposite.

I'm not going to pretend to be able to guess which way things will go. I wouldn't bet heavily on either outcome. You need to be prepared for both.

What to Do

The strategy process for your firm probably includes some type of scenario planning. If it doesn't, it should. HR needs to bring the issue of deflation to the table and be ready to discuss the impact on compensation. HR doesn't need to have the answers, they just need to show a willingness to proactively sit down with the CFO to think through what risks they face.

-David Creelman
www.HR.com