Do companies take into account the increase in inflation in their prices?

While inflation is low and stable, business leaders are right to pay little attention to headline inflation measures when making their own pricing decisions. In this article, we introduce a new set of quarterly questions in a business survey that help determine the extent to which businesses are paying more attention to measures of inflation as inflation rises. We find that, from July 2021 to January 2022, business leaders report not only paying more attention to measures of headline inflation, but also report incorporating these measures into their own pricing decisions.


“Price stability is that state in which expected changes in the general level of prices do not effectively alter the decisions of businesses or households.” —Alan Greenspan

Inflation expectations play a central role in inflation and monetary policy theories. In particular, the more responsive inflation expectations become to actual inflation figures, the more difficult it is for the monetary authority to stabilize inflation without causing a recession.1 Over the past few decades, business leaders would have been well-advised to ignore measures of headline inflation when making pricing decisions, given that these measures have been low and stable relative to other trends. other factors affecting business costs. However, the recent rise in inflation may have caused companies to consider inflation in their own pricing decisions.

We infer companies’ attention and responsiveness to current inflation figures from a regional survey of business expectations. To do so, we introduce a survey-based measure to investigate the relationship between measures of headline inflation and firms’ expectations of their own costs and prices. We conducted three waves of the quarterly survey: July 2021, October 2021 and January 2022.

Taken together, these waves suggest that CEOs and other business leaders are increasingly incorporating aggregate measures of inflation (such as the CPI or PCE) into their decision-making and price expectations. costs. Although measures of headline inflation are still not central to corporate pricing, the proportion of firms that report taking inflation into account when setting prices is steadily increasing.

Fifth District Investigations of Business Activity

The Federal Reserve Bank of Richmond has surveyed CEOs and other business leaders in the Federal Reserve’s Fifth District for nearly 30 years.2 The survey includes approximately 200 to 250 responses per month. The survey panel underweights the smallest businesses, and — due to the history of the survey as well as the general relevance of manufacturing to the Fifth District’s economy — manufacturing businesses make up about a third of the responses. , even though they represent a much smaller share of establishments both in the Fifth District and in the country.3

In addition to questions about variables such as demand, employment and prices, respondents are often asked a series of ad hoc questions. Here we focus on a set of questions posed during the waves mentioned above. These questions focused on the extent to which respondents pay attention to measures of headline inflation and the extent to which they take these measures into account when projecting costs and setting prices.

The importance of aggregate measures of inflation

The first question assesses how closely participants follow measures of headline inflation. We found that the share of companies tracking inflation increased significantly over the six months, as shown in Figure 1.

In July, 21% of respondents said they did not follow inflation measures at all. By January, that share had fallen to 11%. At the same time, the share of respondents who said they follow inflation measures very closely rose from 20% to nearly 30%.

So while it’s still true that many companies don’t track inflation very closely,4 the change in those numbers suggests businesses may be paying more attention after months of the highest headline inflation in decades.

Incorporate inflation measures into pricing

We then asked whether companies take measures of inflation into account in their own pricing decisions. When we asked how important inflation was when setting the prices they charge, we found that the share of companies that said “fairly” or “very” important increased from July to January, as shown in figure 2.

Just 26% of businesses in July and 27% of businesses in October said measures of headline inflation were “very important” when setting expectations for the prices they will charge. That number rose to 31% in January. And in January, just 16% of businesses said overall measures of inflation were “not at all important” in setting their prices, down from 26% in July.

Conclusion

This analysis uses a new approach in an old survey to assess the importance of measures of headline inflation for companies’ thinking about their own price growth. CEOs’ historical inattention to inflation and inflation targets has, somewhat paradoxically, created a favorable environment for monetary policy, where pricing was little affected by inflation outcomes. . This inattention to inflation was rational insofar as prices were stable, generating a virtuous feedback loop where stable inflation begets stable price decisions.

To the extent that inflation remains elevated, CEOs will naturally pay more attention to headline inflation measures, raising the stakes for the FOMC’s communication with pricemakers, perhaps even once the high inflation will have diminished. Our survey readings suggest that some of this could be happening in the past six months.

We thank Jason Kosakow for his assistance in the design and implementation of the survey.


Felipe Schwartzman is senior economist and Sonya Ravindranath Waddell is vice president and economist in the research department of the Federal Reserve Bank of Richmond.


To cite this Economic Note, please use the following format: Schwartzman, Felipe; and Ravindranath Waddell, Sonya. (March 2022) “Are companies taking into account the increase in inflation in their prices?” Federal Reserve Bank of Richmond Economic BriefNo. 22-08.


This article may be photocopied or reprinted in its entirety. Please cite the authors, source and the Federal Reserve Bank of Richmond and include the statement in italics below.

VThe opinions expressed in this article are those of the authors and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

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