serif-font is-medium is-darkblue article-summary”>Why businesses should 'turn a blind eye' to statistics and media reports on inflation
Over the past year and a half, inflation has fallen sharply across the rich world. Although some central banks have now begun to cut interest rates, few are yet ready to claim they have achieved their mission, notes the Economist.
In many countries core inflation, excluding volatile energy and food prices, remains uncomfortably high – at 3.2% in America and 2.9% across the eurozone – even as underlying economies show signs of slowing and financial markets are becoming increasingly nervous. The marathon task of returning price increases to more normal levels is far from over. And the last mile, as so often, proves to be the hardest.
The Self-Fulfilling Prophecies
In recent years, policymakers have worried that inflation expectations will be “destabilized”: that a long period of high inflation will lead both households and businesses to expect more price increases in the future. This is a particularly worrying prospect, given that such beliefs can become self-fulfilling, with workers negotiating for larger wage increases to offset rising prices.
Economists have often focused on how expectations are established among households, but more recent research examines how businesses respond to rising prices. Not only does it hold a few surprises, but it also offers new insight into why the last mile is so difficult.
Surely companies have a good idea of where inflation is headed? After all, they regularly receive data about input costs and how much customers are willing to pay for their goods and services, and they have strong incentives to pay attention. If a company doesn't have a sense of the pricing strategies its competitors will use in the coming months and years, it will likely suffer.
Nevertheless, the bosses seem to be easily swayed by less informed sources of information. In particular, they are influenced by retrospective data from national statistical agencies. A new study by Ivan Yotzov of the Bank of England (BoE), Nicholas Bloom of Stanford University and co-authors looks at how businesses responded to inflation in 2022-24. The researchers look at responses to the Decision Maker Panel, a survey of British CEOs conducted by the BoE every month since 2016.
They find that an unexpected one percentage point increase in CPI inflation causes a 0.7 percentage point increase in future inflation expectations in the following days and continues to have an effect in the following weeks. Last year, Yuriy Gorodnichenko of the University of California, Berkeley, and colleagues found a similar result, using similar methodology, in Israel, where an unexpected one percentage point increase in inflation was associated with a 0.5 percentage point increase in expectations.
Indeed, the impact of official inflation statistics extends even further than companies' views on the general outlook for inflation. It also affects their views on the likely path of their own prices. Analysis by the BoE's Decision Making Committee finds that a one percentage point increase in measured inflation leads to a 0.6 percentage point increase in expected inflation.
These expectations are distorted in a way that would worry central bankers.
Higher inflation readings pull expected prices up more than lower inflation readings drag them down.
The media 'fuels' inflation
The media may be partly responsible. Messrs. Yotzov and Bloom constructed an index of inflation in the British press, based on the share of newspaper articles reporting rising prices. Examining this, the researchers and their colleagues found that days with many reports of inflation were associated with increased inflation expectations among firms.
They hypothesized that firms received information about inflation from the media. and not directly from the national statistical office. Between 2019 and October 2022, when the CPI peaked at 11.1%, UK inflation increased sixfold. By the same point, media coverage had also increased sixfold from its 2010-19 average. But during the period in which inflation subsequently declined, media interest waned.
