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Wednesday, 8 June 2011

Salaries and wages maintained constant during low inflation

Salaries and wages maintained constant during low inflation



The annual indexation or measurement in units of constant purchasing power of salaries and wages in a low inflationary environment is a blessing to users since it enables them to maintain the real values of salaries and wages constant during inflation. This often involves labour union negotiations with employer bodies. They usually agree on an annual increase in the depreciating monetary unit payment values for constant real value non–monetary salaries and wages to maintain their purchasing power constant on an annual basis in a low inflationary economy where the real value of the monetary unit of account is continuously being eroded by inflation. The nominal values of constant real value non–monetary salaries and wages are thus updated or indexed in terms of the annual CPI to cover or compensate for at least the expected annual rate of erosion in the real value of the depreciating monetary unit which is the depreciating monetary unit of account for accounting purposes as well as the depreciating monetary medium of exchange for payment purposes in the economy during low inflation. The period is normally for the year ahead. They often agree on an additional percentage increase for increases in productivity and / or for social security reasons.



Both parties to the salary and wage negotiations agree that constant real value non–monetary salaries and wages cannot be accounted or valued at traditional nominal Historical Cost implementing the very erosive stable measuring unit assumption whereby it is simply assumed that changes in the purchasing power of depreciating money are not sufficiently important to require measurement in units of constant purchasing power during inflation. Workers would not receive the constant purchasing power values of their salaries and wages when fixed HC salaries and wages are paid in depreciated monetary units whose real values are continuously being eroded by inflation. They would not receive the full constant real non–monetary values of their salaries and wages.



“Inflation is always and everywhere a monetary phenomenon.” Milton Friedman.



Inflation can only erode the real value of the depreciating monetary medium of exchange (depreciating money, i.e. the depreciating monetary unit inside an inflationary economy) and other depreciating monetary items.



Inflation has no effect on the real values of salaries and wages which are constant real value non–monetary items. Inflation can only erode the real value of money and other monetary items – nothing else. Inflation has no effect on the real value of non-monetary items. The very erosive stable measuring unit assumption implemented as part of the traditional HCA model when salaries and wages are fixed over time, unknowingly, unintentionally and unnecessarily erodes the real value of salaries and wages when they are not measured in units of constant purchasing power in terms of the monthly CPI during low inflation.



Inflation cannot erode the real value of non–monetary items. Inflation can only erode the real value of the unstable monetary medium of exchange (the unstable monetary unit – unstable money) used to transfer the constant real non–monetary values of salaries and wages from the employer to the employee.



“Purchasing power of non monetary items does not change in spite of variation in national currency value.”



Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005, Page 9.








The erosion at a rate equal to the annual rate of inflation of all constant real value non–monetary items never maintained constant under HCA during inflation automatically stops forever the very moment the Boards of Directors of companies implement the IFRS–approved financial capital maintenance in units of constant purchasing power model (CIPPA) in all entities that at least break even during low inflation – all else being equal. The choice is theirs. The power to stop the erosion of real value in the real economy is in their hands – as authorized in IFRS since 1989 in the IASB´s original Framework (1989), Par 104 (a) which is applicable in the absence of specific IFRS. It is the choice of the accounting model (CIPPA or HCA) and not inflation that automatically maintains or generally erodes the existing constant real non–monetary value of constant real value non–monetary items never maintained constant in low inflationary economies.



The constant real non–monetary values of salaries and wages expressed in terms of the depreciating unstable monetary unit as the depreciating unstable monetary unit of account are presently being maintained constant on an annual basis in the first month of payment in low inflationary economies when their nominal monetary values are indexed or updated by means of the CPI in low inflationary environments. This happens not because of a lowering of inflation, but because of employers and trade unions valuing salaries and wages in units of constant purchasing power on an annual basis instead of the Historical Cost measurement basis for this particular purpose. Salaries and wages are then normally kept fixed for the 12 month period of the accounting year; i.e. they are not updated or measured in units of constant purchasing power on a monthly basis. The stable measuring unit assumption is generally applied with monthly payments after the annual update.



If the parties to the salary and wage determination process were to agree to value salaries and wages annually at fixed Historical Cost (in nominal monetary units) – like Iceland recently decided to freeze salaries because of their financial crisis –  then their annual constant real non–monetary values are eroded at a rate equal to the annual rate of inflation because constant real value non–monetary salaries and wages are expressed in term of the depreciating monetary unit of account and are normally paid in depreciating monetary units. Salaries and wages are not depreciating monetary items. They are constant real value non–monetary items on an annual and on a monthly basis. They are, however, - after the annual update - normally paid monthly in depreciating money during low inflation.



“Income Statement



This standard requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date.” IAS 29, Par 26.



All items in the income statement are constant real value non–monetary items to be continuously updated by applying the monthly change in the annual CPI during low inflation and deflation. The real values of salaries and wages would thus not be eroded by inflation if they were valued in nominal monetary units (fixed salaries and wages), but by the choice of the measurement basis, namely, Historical Cost, i.e. in nominal monetary units, which means the implementation of the very erosive stable measuring unit assumption whereby it is considered that the continuous erosion of the purchasing power of the monetary unit is not sufficiently important during low inflation in order to require the indexation or measurement in units of constant purchasing power of the existing constant real values of constant real value non–monetary salaries and wages by means of the monthly CPI in order to maintain their existing constant real non–monetary values constant. What is done, in essence, is it is assumed that the constantly depreciating monetary unit of account – the depreciating monetary unit – is perfectly stable when the stable measuring unit assumption is applied. It is assumed, in principle, that the depreciating monetary unit is perfectly stable whenever the stable measuring is implemented.


Nicolaas Smith.

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