Unit Cost Expectations and Uncertainty: Firms' Perspectives on Inflation

Brent H. Meyer, Nicholas B. Parker, and Xuguang Simon Sheng
Working Paper 2021-12
March 2021

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Abstract: We rely on the Atlanta Fed's Business Inflation Expectations survey to draw inference about firms' inflation perceptions, expectations, and uncertainty through the lens of firms' unit (marginal) costs. Using methods grounded in the survey literature, we find evidence that the concept of "aggregate inflation" as measured through price statistics like the consumer price index hold very little relevance for business decision makers. This lack of relevance manifests itself through experiments (including randomized controlled trials) that show how researchers word questions to elicit inflation expectations and perceptions significantly changes firms' responses. Our results suggest firms have become rationally ignorant of the concept of inflation in a low-inflation environment. Instead, we find that unit (marginal) costs are the relevant lens with which to capture firms' views on the nominal side of the economy. We then investigate both firm-level (micro) and aggregated (macro) probabilistic unit cost expectations. On a firm level, unit costs are an important determinant of firms' price-setting behavior. Aggregating across firms' beliefs, firms' unit cost perceptions strongly comove with official aggregate price statistics, and, importantly, firms' expectations for the nominal side of the economy have little in common with the "prices in general" expectations of households. Rather, firms' aggregated beliefs strongly covary with the inflation expectations of professional forecasters and market participants.

JEL classification: E31, E52

Key words: bimodality, inflation expectations, probability distributions, randomized controlled trials, uncertainty, unit cost


The authors thank Longji Li, Dingqian Liu, and Brian Prescott for excellent research assistance and the Federal Reserve Bank of Atlanta for its ongoing support of the Economic Survey Research Center and the Business Inflation Expectations survey. They also thank Jose Maria Barrero (discussant), Carola Binder (discussant), Wojtek Charemza, and participants at the Philadelphia Fed Conference on "Real-Time Data Analysis, Methods and Applications" and the 21st IWH-CIREQ-GW Macroeconometric Workshop for helpful comments. Bernie Andrade kindly provided us the R code to fit the bimodal distribution. 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. All results have been reviewed to ensure that no confidential information was disclosed.

Please address questions regarding content to Brent H. Meyer, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 60208; Nicholas B. Parker, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 60208; or Xuguang Simon Sheng, Department of Economics, American University, 4400 Massachusetts Avenue NW, Washington, DC 20016.

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