Brent H. Meyer, Brian C. Prescott, and Xuguang Simon Sheng
Working Paper 2023-12
September 2023

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Using the Federal Reserve Bank of Atlanta's Business Inflation Expectations (BIE) survey, which has been continuously collecting subjective probability distributions over own-firm future unit costs since October 2011, we document two facts about firms' marginal cost expectations and risk during the COVID-19 pandemic. First, in the early months of the pandemic, firms, on net, saw COVID-19 largely as a demand shock and lowered their one-year-ahead expectations. However, as the pandemic wore on, firms' one-year-ahead unit cost expectations rose sharply alongside their views on supply chain and operating capacity disruptions. Second, the balance of unit cost risks shifted sharply over the course of the pandemic, and by the end of 2022, upside risks had sharply outweighed perceived downside risks during the year ahead. We find that both positive demand shocks (for example, large order backlogs) and negative supply shocks (such as long supplier delivery times and labor shortages) have contributed to elevated short-term unit cost expectations and risk. Specifically, supply shocks accounted for roughly 40 percent of the increase in manufacturers' and nearly one-third of service-providers' unit cost expectations.

JEL classification: E31, E32

Key words: business expectations, COVID-19, demand shock, inflation, pandemic, supply shock

The authors thank the guest editor Catherine Kyrtsou, two anonymous referees and participants at the 43rd International Symposium on Forecasting, the 5th Behavioral Macroeconomics Workshop, Central Bank Research Association 2023 annual meeting, conference on "Inflation Dynamics in a New Era of Energy Price Shocks," and seminar at George Washington University for their helpful comments. This research was initiated while Brian Prescott was in the Research Department at the Federal Reserve Bank of Atlanta. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Brent Meyer, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree St. NE, Atlanta, GA, 30309; Brian Prescott, Department of Economics, Washington University in St. Louis, 1 Brookings Drive, St. Louis, MO, 63130; or Xuguang Simon Sheng, Department of Economics, American University, 4400 Massachusetts Avenue, NW. Washington, DC 20016.

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