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August 2, 2022
Firms' Inflation Expectations: Not Unanchored, but Perhaps Unsettled?
Last week, the Federal Open Market Committee (FOMC) again decided to raise the federal funds rate target by 75 basis points in an effort to help curb inflation. While Chair Powell, in his press conference following the July FOMC meeting, noted the lag in monetary policy's influence on inflationary pressures, he also pointed out that "if you have a sustained period of supply shocks, those can actually start to undermine or to work on de-anchoring inflation expectations" (see the 16-minute mark of the video from the press conference).
We, too, share this worry. In fact, it's been something we've been concerned about here at the Atlanta Fed since last fall. In a speech at Peterson Institute speech in October 2021, Atlanta Fed president Raphael Bostic said: "I continue to believe currently elevated inflation is episodic, driven by pandemic conditions such as disruptions in supply chains and labor markets. A major caveat, though, is that the severe and pervasive supply chain issues will probably last longer than most of us initially expected. Up to now, indicators do not suggest that long-run inflation expectations are dangerously untethered. But the episodic pressures could grind on long enough to unanchor expectations."
After monitoring the evolution of our Business Inflation Expectations (BIE) survey data for the better part of a year, we're still concerned. While the BIE has only been around since 2011, and the current period of high inflation is the only shock we've picked up in our data, the speed and sharpness of the increase in our survey-based measure of inflation expectations have left us wondering: How unsettled are longer-run inflation expectations?
For those not familiar with the BIE survey and its unique perspective on firms' inflation expectations, it's a monthly regional survey that the Atlanta Fed conducts to measure firms' inflation expectations in the Sixth District. Rather than elicit firms' aggregate inflation expectations, we ask them about their own-firm unit cost expectations—an input that is directly related to their own-firm price formation strategies (see Meyer et al. 2021). Moreover, the expectations we elicit are probabilistic, meaning we can gauge not only an individual firm's average expectations but also the level of certainty with which firms are holding those views. What does the BIE tell us about how firms are reacting to the highest bout of inflation the United States has experienced in 40 years?
By now, the current inflationary environment should be apparent to just about everyone. It's affecting all areas of the consumer market basket and has become a recurring headline in the news. It's even become a popular search term on Google. In fact, inflationary pressures have risen to heights that we haven't seen since the early 1980s, during the period known as the Great Inflation. As the chart below shows, roughly three-quarters of prices in the consumers' market basket (by expenditure weight in the consumer price index, or CPI) have risen at rates equal to or exceeding 5 percent (see chart 1). In June, more than 90 percent of prices in the market basket outpaced the 3 percent mark.
This high-inflation environment is not lost on businesses. In fact, firms' perceptions (unit-cost realizations) have been highly correlated with the evolution of overall inflation over the course of the pandemic. Chart 2 plots firms' realized unit-cost growth over the past year and compares it to the year-over-year growth rate in overall inflation as measured by the GDP price index, which is the broadest measure of inflationary pressures as it goes beyond just consumer prices to gauge price pressures in the entire economy.
In the world of survey-based measures of inflation expectations, our BIE survey has one clear advantage: not only can it track the evolution of expectations but it can also provide clear insight into firms' perceptions of the current environment, which is very useful in gauging the external validity of those expectations. To us, this insight compellingly shows that firms in our BIE panel are clearly seeing the facts when it comes to inflation.When general prices increase, businesses' input costs also increase, and as higher costs squeeze margins, many firms will pass some or all of those costs on to their customers in the form of (you guessed it) higher prices. Survey evidence suggests a correlation between supply chain disruptions and higher year-ahead inflation expectations. We've previously noted that although supply chain disruption isn't the only factor influencing expectations, firms with the largest levels of disruption tend to hold higher expectations for inflation in the year ahead (see chart 3). So what are firms telling us about their expectations for the evolution of inflation over the year ahead and beyond?
Perhaps the easiest way to see how much both short-run and five-year-ahead (long-run) inflation expectations have moved over the past two years is to index them to their prepandemic growth rates. In chart 3, we depict these expectations, indexing each series to 100 in the fourth quarter of 2019. What we can see is that both short-run and longer-run expectations have increased dramatically.
While initially short-run expectations dipped at the start of the pandemic (amid widespread lockdowns and a substantial decline in economic activity), starting early in 2021, firms' short-run inflation expectations began to increase sharply. Later in 2021, firms' long-run expectations also started to show a meaningful pickup. Firms' short-run inflation expectations have roughly doubled relative to the prepandemic period. And firms' longer-run expectations are about 25 percent higher than the expectations we saw in late 2019.We can dig a bit deeper into firms' longer-run expectations by examining the average probability weights that firms assign to the potential outcomes for longer-run unit costs at different periods, as chart 4 shows. In this case, we look at the fourth quarter of 2019 and the second quarters of 2020, 2021, and 2022.
These histograms illustrate the degree to which firms' inflation expectations have shifted over the course of the pandemic. Here, two aspects of this shift stand out to us. First, through the middle of 2021, even as inflation metrics were beginning to heat up, the distribution of firms' longer-run expectations hadn't moved much. Second, during the past year, the average probability distribution shifted starkly. The typical firm in our panel is now assigning nearly a 60 percent probability to longer-run unit cost increases of at least 3 percent per year. Moreover, their modal expectation is for longer-run unit costs to increase by 5 percent or more annually—which means that more firms anticipate the need to adjust their unit costs by more than 5 percent per year in the long run. To put this bluntly, we haven't witnessed anything like this in the decade-long existence of this survey.
A couple of caveats are worth mentioning here. First, although this is the first sizable "inflation shock" we've been able to examine in the BIE survey, we do not have a long enough time series to compare the current era to the aforementioned Great Inflation. At best, we can suggest that—given the high correlation between firms' unit-cost expectations and professional forecasters' expectations—our measures would have performed similarly in the '70s and '80s. Also, as the extensive literature on consumer expectations documents, the possibility exists for business executives to base their projections for future unit costs solely on current conditions (a phenomenon economists call adaptive expectations). Still, that last point cuts two ways. First, it's possible that, should inflation ebb meaningfully in the coming months, these longer-term expectations might follow suit. Conversely, persistently high inflation could further cement such expectations for the longer run, making it more challenging for policymakers to bring inflation back to their price-stability goals.
Said another way, the current bout of high inflation is unusual in many different ways, and how it will play out remains fraught with uncertainty. Firms' short- and long-run expectations have risen sharply, and longer-run expectations show a clear rise in the average firm's probability distribution, to the extent that nearly one-third of the weight is being assigned to anticipated cost increases greater than 5 percent. So as we continue to delve further into these expectations and monitor upcoming developments, we're left pondering the question: is this how "unanchoring" begins?
March 22, 2021
Inflation Expectations Reflect Concerns over Supply Disruptions, Crimped Capacity
As the COVID-19 pandemic stretches into its second year, we've seen evidence of changes in how it, and attendant policy measures designed to support the economy, are affecting firms. Early in the pandemic, firms generally appeared more concerned with flagging demand and falling revenue than issues of having sufficient supplies (notwithstanding obvious acute issues at grocery stores). Rather, at least through August 2020, firms saw the COVID-19 pandemic as disproportionately a concern of demand rather than supply —so much so, in fact, that firms scaled back on wages, expected to lower near-term selling prices, and lowered their one-year-ahead inflation expectations to a series low (going back to 2011). These findings, based on our Business Inflation Expectations (BIE) survey, are consistent with other academic research based on quarterly earnings calls of public firms and research out of the Harvard Business School.
However, as the pandemic continued to unfold and as relief and support continued to flow into the economy via ongoing monetary and fiscal policy efforts, many firms have begun to indicate a shift in concerns—from flagging demand toward concerns about fulfilling demand. Although the recovery remains decidedly uneven across industries, strong shifts in consumer activity (toward durable goods purchases) amid crimped production due to COVID-19 restrictions appear to have disrupted supply chains, to the extent that shipping containers sit mired in ports amid "floating traffic jams." Along with these difficulties, firms continue to indicate issues with employee availability, which hampers their operating capacity.
To investigate the breadth and intensity of these disruptions in supply chains and business operating capacity, we posed a few questions to our BIE panel during the first week of March. Specifically, we asked whether they'd recently experienced some form of supply chain disruption (anything from supplier delays to delays in shipping to their customers) as well as their experiences with crimped operating capacity (due to a variety of issues, ranging from employee availability to physical distancing issues). While we borrowed those two questions more or less directly from the U.S. Census Bureau's Small Business Pulse Survey, we also extended them by asking firms to gauge the intensity of these disruptions (on a scale ranging from "little to none" to "severe"). In addition, we posed these questions to medium-sized and larger firms in addition to those with fewer than 500 employees.
Chart 1 below shows the results. Regarding supply chain difficulties, we found that more than half of the firms in our panel felt some form of supplier delay, and the level of disruption is "moderate to severe" for 40 percent of them—a striking finding for a few reasons. First, our panel, like the nation, is disproportionately weighted toward service-providing firms (roughly 70 percent service firms to 30 percent goods producers). Second, just a few months ago (December 2020), firms ranked "supply chain concerns" as eighth out of their top 10 concerns for 2021. These results align with well-known diffusion indexes—the Institute for Supply Management Manufacturing and Business Services surveys—that have shown that a greater share of firms are experiencing slower deliveries and lower inventories in recent months.
In addition to issues receiving raw materials and intermediate goods from suppliers, a little more than one in three firms in the BIE panel also indicated that they themselves experienced delays in fulfillment, and the responses to the question on disruptions to operating capacity allow us some insight into the potential causes of these delays.
Here, a third of firms indicated that they were having difficulties with their employees' availability for work. Presumably, these issues stem from employees' concerns over contracting the virus, outbreaks causing production delays, or employees' inability to work due to familial issues such as childcare or the care of other dependents. One out of five respondents indicated that the intensity of disruption to operating capacity stemming from employee availability was moderate to severe. The same share of panel respondents—a fifth—indicated that a lack of adequate supplies and inputs on hand (likely due to supplier delays) caused a shortfall in production relative to capacity.
Comparing these responses to the Census Bureau's Small Business Pulse Survey, we find that the relative rankings of sources of disruption are quite similar—supplier delays far outweigh other supply chain disruptions, and the availability of employees for work are the most frequently cited sources of disrupted operations. Yet we find a greater incidence of disruption (even if we restrict our sample only to small firms). For example, 40 percent of firms surveyed by the Census Bureau indicated supplier delays, which slightly more than half of firms indicated to us. Such a discrepancy is unlike previous comparisons to other Census Bureau work (which match quite closely) and could be the result of a number of survey-specific factors. For instance, the types of respondents differ markedly—whereas the BIE elicits responses mainly from those in the C-suite and business owners, the census typically aims for someone in the accounting department. The number of response options also differs, and census respondents have seen these questions on disruption to supply chains and operating capacity numerous times over the pandemic.
Although disrupted supply chains and crimped operating capacity are significant enough to warrant attention on their own merits, another aspect of these issues deserves attention. Concurrent with widespread supply chain disruption and hobbled operating capacity, firms have ratcheted up both their perceptions of current inflation and their expectations for unit costs going forward (see chart 2).
When we survey firms' expectations around inflation, we prefer to gauge their views on the nominal aspects of the economy through the lens of their own-firm unit costs, as other Atlanta Fed research shows. After falling to the lowest levels on record during the depths of the pandemic, firms' perceptions of unit cost growth over the past year have risen sharply. Interestingly, these perceptions correlate tightly with movements in official aggregate price indexes, such as the gross domestic product price index (also called the GDP deflator) and the personal consumption expenditures price index.
Firms also appear to anticipate higher unit-cost growth in the year ahead. Since hitting a low in April 2020, firms' unit-cost (basically, inflation) expectations for the year ahead have surged to all all-time high just 11 months later. Not only does that kind of volatility speak to the dramatic and disparate impact COVID-19 has had on business activity, but it also suggests that the underlying drivers of these expectations have shifted markedly. (Incidentally, chart 2 shows that this measure of firms' inflation expectations moves in lockstep with professional forecasters' views.)
Indeed, in sharp contrast to their views early in the crisis, firms' one-year inflation expectations appear to have risen sharply alongside their views on supply chain and operating capacity disruption. Chart 3 shows a simple scatterplot between firms' one-year-ahead inflation expectations and a summary measure of the intensity of their disruption. To create this measure, we first assigned a score from 0 to 4 to each special question response based on whether they responded "None," "Little to none," "Mild," "Moderate," or "Severe." We then add their scores to obtain their disruption index. The mean disruption index value for firms in goods-producing industries is 9.3 and 6.6 for service-providing firms. And consistent with anecdotes and news stories, the disruption is highest in manufacturing industries (9.75) and trade and transportation industries (9.1).
Chart 3 visualizes the relationship between inflation expectations and the index of supply chain disruption. Although supply chain disruption isn't the only factor influencing year-ahead unit cost expectations, we can see that firms with the largest levels of disruption tend to be those that hold higher expectations for inflation in the year ahead.
For another perspective, chart 4 shows that the relationship between inflation expectations and disruption depends on whether the responding firm belongs in the goods-producing sector or the service-providing one. While both have strong positive relationships, it's interesting to note that the relationship is even stronger among firms in the goods-producing sector. While perhaps an unsurprising result, it is a reassuring one given that the most-cited reason for supply chain disruptions—supplier delays—is more likely to affect goods-producing firms.
Overall, when one contrasts the early portion of the pandemic with the more recent period, significantly more firms indicate that they are experiencing disruptions in their supply chain and operating capacity. More than 50 percent of our survey panelists indicated delayed deliveries from suppliers (and for most of those respondents, the disruption is moderate to severe). Combined with crimped operating capacity due largely to uncertain employee availability and lack of inputs, firms are beginning to view these disruptions as factors that are driving up their unit costs and leading to higher inflation expectations. We can connect the dots from firms' year-ahead inflation expectations to the intensity of these supply and production disruptions. Firms experiencing the most intense disruption tend to be those with the highest expectation of future inflation. This explanation tamps down the speculation that the potential inflationary impact of recent fiscal stimulus on demand is behind heightened year-ahead inflation expectations.
April 17, 2020
Businesses Are in Uncharted Waters
Inflation expectations in our April Business Inflation Expectations (BIE) survey fell to an all-time low (going back to October 2011) of 1.4 percent, plunging far below its next lowest level of 1.7 percent (most recently observed in February 2020). Perhaps unsurprisingly, firms have bigger worries on their minds. And our boss, President Raphael Bostic, agreed, noting on Wednesday that "inflation at this point is not something I'm particularly worried about."
The drop in inflation expectations was not the only historical low that our survey results uncovered. Firms' assessments of current sales levels relative to what they consider "normal" levels fell precipitously. Recovering from the 2007–09 financial crisis and recession, this quantitative sales gap measure had slowly been moving toward zero (or "normal" sales levels) alongside solid gains in gross domestic product growth and previously strong job gains. However, that all changed in April. Our survey, which was in the field from April 6 to 10, showed an extraordinarily large decline in sales levels relative to normal—from 2.5 percent below normal in the first quarter to 32 percent below normal in April (see the charts). The decline in sales had an impact on firms of all sizes, but smaller firms reported a much larger hit to sales than did firms with more than 100 employees.
Our survey's special questions this month focused on the level of disruption the coronavirus outbreak was causing for southeastern firms. We asked participating firms to assess disruption to their business operations and sales activity, on a scale of "no disruption" to "severe disruption," and it's obvious that a majority of firms in our panel have experienced severe disruption to their sales activity (see chart 2). The table indicates how disrupted firms' operations and sales were. Among those firms experiencing severe disruption, current sales levels have been roughly halved relative to normal conditions. The results suggest that the disruption associated with the outbreak has not hit all firms equally. There is also some evidence of dispersion (reallocation) across firms, as a small share of firms that indicated they are experiencing low levels of disruption are seeing stronger-than-usual sales levels.
As firms continue to grapple with the unprecedented impact and uncertainty that the coronavirus outbreak has inflicted, we wanted to get a rough sense of how long they expect these unusual conditions to persist and how long they can weather the economic shutdown without seeking new sources of funding. The left-hand graph in chart 3 shows the cumulative distribution function (CDF) for how many months before business operations return to normal. The CDF on the right-hand side plots how long firms can continue to operate in the current environment without seeking additional funding to backstop operations.
The typical (median) response was an expectation that it will be about four more months for business operations to return to normal (though the tail is long, and about 10 percent thought a year or longer is in order). Perhaps the silver lining here is that the typical response was an expectation to be able to operate for another six months before needing to tap additional sources of funding. Assuming that much of the economic activity that has been shuttered begins to resume by the beginning of the fourth quarter and conditions do not deteriorate further, the "typical" firm in our panel should be able to continue to operate.
However, digging into the individual responses reveals some nuance in this relationship. The cross-sectional relationship between a business decision-maker's assessments of the length of time he or she can continue to operate without securing additional funding and the length of time before resuming normal activity carries a correlation coefficient of just 0.2. (This finding essentially means that survey respondents often had different notions of when they would be able to resume normal business operations and need to tap additional funding.) The typical firm expects to be able to resume normal operations about a week or so before they need to tap additional funding. And, perhaps more importantly, nearly 40 percent of firms in our sample expect they'll need to secure additional funding before their operations return to normal.
Finally, although inflation isn't the first thing on everyone's mind at the moment, we did ask firms about their price expectations (see chart 4). While roughly 60 percent expect to hold steady on prices over the next six months, roughly a quarter of the panel expect to lower prices, and just 15 percent expect to increase them. On average, firms expect to lower prices by 2.2 percent, and there appears to be a relationship between COVID-related disruption to sales activity and expected price declines.
Across many dimensions, the disruption caused by the current pandemic is without precedent. Many firms headquartered in the Southeast have indicated severely disrupted business operations and sales activity, disruptions that appear to have caused incredibly sharp declines in sales levels. The typical firm in the panel expects this disruption to persist at least through the summer months (which may foreshadow the likely shape of the recovery). And—though not a primary concern at the moment—inflation expectations are the lowest we've recorded in more than 100 consecutive months of conducting this survey. In many ways, we appear to be in uncharted waters.
March 23, 2018
What Are Businesses Saying about Tax Reform Now?
In a recent macroblog post, we shared some results of a joint national survey that is an ongoing collaboration between the Atlanta Fed, Nick Bloom of Stanford University, and Steve Davis of the University of Chicago, and Jose Barrero of Stanford University. (By the way, we're planning on calling this work the "Survey of Business Executives," or SBE.).
In mid-November, we posed this question to our panel of firms:
If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures in 2018?
At the time, we (and perhaps others) were a little surprised to find that roughly two-thirds of respondents indicated that tax reform hasn't enticed them into changing their investment plans for 2018. Our initial interpretation was that the lack of an investment response by firms made it unlikely that we'd see a sharp acceleration in output growth in 2018.
Another interpretation of those results might be that firms were unwilling to speculate on how they'd respond to legislation that was not yet set in stone. Now that the ink has been dry on the bill for a while, we decided to ask again.
In our February survey—which was in the field from February 12 through February 23—we asked firms, "How has the recently enacted Tax Cuts and Jobs Act (TCJA) led you to revise your plans for capital expenditures in 2018?" The results shown below—restricted to the 218 firms that responded in both November 2017 and February 2018—suggest that, if anything, these firms have revised down their expectations for this year:
You may be thinking that perhaps firms had already set their capital expenditure plans for 2018, so asking about changes in firms' 2018 plans isn't too revealing—which is why we asked them about their 2019 plans as well. The results (showing all 272 responses in February) are not statistically different from their 2018 response. Roughly three-quarters of firms don't plan to change their capital expenditure plans in 2019 as a result of the TCJA:
These results contain some nuance. It seems that larger firms (those with more than 500 employees) responded more favorably to the tax reform. But it is still the case that the typical (or median) large firm has not revised its 2019 capex plans in response to tax changes.
Why the disparity between smaller and larger firms? We're not sure yet—but we have an inkling. In a separate survey we had in the field in February—the Business Inflation Expectations (BIE) survey—we asked Sixth District firms to identify their tax reporting structure and whether or not they expected to see a reduction in their tax bill as a result of the TCJA. Larger firms—which are more likely to be organized as C corporations—appear to be more sure of the TCJA's impact on their bottom lines. Conversely, smaller "pass-through" entities appear to be less certain of its impact, as shown here:
For now, we're sticking with our initial assessment that the potential for a sharp acceleration in near-term output growth is limited. However, there is some upside risk to that view if more pass-through entities start to see significantly smaller tax bills as a result of the TCJA.
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