Let me start by asking which you’d prefer:
- A 10% raise?
- A 3% raise?
If you’re like almost everyone, the answer is hands down #1. But let me re-phrase the question a bit. Which would you prefer?
- A 10% raise in 1980?
- A 3% raise in 2009?
Is your answer still the same? I bet you think it’s a trick question because I added a year to the options. You’re right, it IS a trick question! The years 1980 and 2009 are special. Can you guess why? 1980 is very well known for having a very high inflation rate whereas 2009 is known for being a deflationary year (a year where the inflation rate is negative). In 1980 the inflation rate was 13.5% whereas in 2009 it was -0.4%. Having brought this new information to light, is your answer still the same?
In other words, which do you prefer:
- 10% raise at 13.5% inflation in 1980 = a real -3.5% raise in terms of purchasing power
- 3% raise at -0.4% inflation in 2009 = a real 3.4% raise!
Looking at the numbers adjusted for inflation, option #2 is now by far the best economical choice, beating option #1 by almost 7%!! Option #1 is actually a pay cut!
Now here’s the kicker, although most people realize option #2 is the best economically, the majority of us FEEL that the person in option #1 is HAPPIER with their raise than the person in option #2. Notice here I said feel happier, NOT that they were financially ahead! Although we’re able to differentiate between the two, most people still believe they would feel happier with option #1!!
What’s more, this same research paper (Money Illusion) also discovered that people believe the person in option #2 was more likely to leave their job. Basically, as William Poundstone summarized in his book Priceless, the overall theme of the paper is:
“$$$ = happiness = actual dollars NOT ADJUSTED FOR INFLATION”.
So how do you get a pay cut and be happy about it? Get a raise, but have that raise be less than the rate of inflation.