What do you expect? Surveying inflation expectations

At the National Bureau of Economic Research (NBER) summer institute in 2007, Federal Reserve Chairman Ben Bernanke challenged researchers with three questions:

• How should the central bank best monitor the public's inflation expectations?
• How do changes in various measures of inflation expectations feed through to actual pricing behavior?
• What factors affect the level of inflation expectations and the degree to which they are anchored?

A broad interpretation of this challenge implies that policymakers would benefit from a better understanding of how inflation expectations are formed and influence prices. This is a tall order, to be sure, and investigations aimed at improving this understanding are well under way.

For example, the Federal Reserve Bank of New York has an initiative to better measure and understand the inflation expectations of households. And the Federal Reserve Bank of Cleveland has developed a measure of inflation expectations derived from a model of financial data and economic forecasts. There are certainly many other examples, and it seems fair to say that the chairman's call to action has been taken up by many researchers both inside and outside of the Federal Reserve System.

Among the more obvious gaps in our knowledge of inflation expectations is the inflationary sentiment of businesses. Taking from the chairman's NBER talk:

"Information on the price expectations of businesses—who are, after all, the price setters in the first instance—as well as information on nominal wage expectations is particularly scarce.

"…[Further,] how do changes in various measures of inflation expectations feed through to actual pricing behavior?"

The Federal Reserve Bank of Atlanta has decided to take up this mantle. Today, we are unveiling our first Business Inflation Expectations survey—a monthly, online survey of the pricing environment and sentiment of the businesses in the Sixth Federal Reserve District (those in Alabama, Florida, Georgia, and parts of Louisiana, Mississippi, and Tennessee). Approximately 300 business owners and top executives receive our survey each month. This panel represents a broad cross-section of business and roughly matches the industrial composition of the U.S. economy.

Information gathered from our panel allows us to measure the inflation expectations and inflation uncertainty of businesses—as measured by their expectations for unit costs over the coming 12-month period and the uncertainty surrounding those expectations. Panelists also weigh in on current business conditions and margins as well as potential sources of price pressure in the coming year. According to the January survey just released, our panel indicated that, on average, they expect unit costs to rise 1.8 percent over the next 12 months, down just slightly from 1.9 percent in December. In other words, the unit cost increases expected by the businesses in our panel are comparable to recent year-ahead inflation forecasts of private economists.

The firms in our panel indicate that they are still operating in an environment of below-normal sales and depressed margins, although both have been slowly improving since October. Looking forward, firms anticipate labor costs will put little or only moderate upward pressure on prices in the year ahead. Expectations for nonlabor costs are similar, though 14 percent of panelists predict a strong upward influence on prices coming from materials and other nonlabor inputs. Respondents also anticipate that their sales, productivity, and margin adjustments are likely to have a very small, though positive, influence on prices in the coming year.

In addition to gauging firms' price-setting environment and year-ahead unit cost expectations, we are using the survey to investigate issues of longer-term interest for research and policy. Often we will put to our panel a special question designed for this purpose.

This month, we asked firms to tell us how frequently they make small price adjustments. The results of this inquiry were mixed, but intriguing. A significant share of firms indicated that they do not make very small price adjustments. Specifically, 35 percent responded that they don't make price adjustments of less than 1 percent. Another 14 percent indicated that very small price adjustments are rather rare (about one or two per every 20 price changes). But for a small proportion of our panel, very small price adjustments were common. Fifteen percent indicated that at least half their price changes were very small changes.

We obviously have many more questions to ask of our panel—this is only the beginning of our survey. But we think we're headed in the right direction.

If you want to learn more about our survey or be alerted when new survey data become available, go to the Atlanta Fed's Business Inflation Expectations Survey page.

Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

Nicholas Parker, economic research analyst, all with the Atlanta Fed

Keeping an eye on inflation

Where's inflation heading? Well, here's what the minutes of the December meeting of the Federal Open Market Committee (FOMC) had to say on the subject:

"Participants observed that inflation had moderated in recent months as the effects of the earlier run-up in commodity prices subsided . . . many participants judged that the moderate expansion in economic activity that they were projecting . . . would be consistent with subdued inflation going forward."

But not all FOMC meeting participants viewed these trends with equanimity:

"Indeed, some expressed the concern that, with the persistence of considerable resource slack, inflation might run below mandate consistent levels for some time."

According to Reuters, San Francisco Fed President John Williams said it this way:

"The data so far on the inflation front are confirming my view that inflation is ebbing and moving to be too low, and that is an important driver of my thinking about policy."

But as you might expect, some see the inflation risks weighing a bit on the other side of the scale. Again, from the December FOMC meeting minutes:

"Some participants were concerned that inflation could rise as the recovery continued . . . A few participants argued that maintaining a highly accommodative stance of monetary policy over the medium run would erode the stability of inflation expectations."

In fact, Philadelphia Fed President Charles Plosser had this to say in a speech earlier this week:

"I do anticipate that with many commodity prices now leveling off or falling, and inflation expectations relatively stable, inflation will moderate in the near term . . .

"But as a policymaker, my focus is less on the near term and more on the medium term. Looking further ahead, I believe we must monitor the inflation situation very carefully, particularly in this environment of very accommodative monetary policy. Inflation most often develops gradually, and if monetary policy waits too long to respond, it can be very costly to correct. Measures of slack such as the unemployment rate are often thought to prevent inflation from rising. But that did not turn out to be true in the 1970s. Thus, we need to proceed with caution as to the degree of monetary accommodation we supply to the economy."

What doesn't seem to be in dispute is that monitoring the data for any sign that the inflation trend is shifting—either higher or lower—is probably a good idea. And there are a lot of data to watch. In a speech last year to the Calhoun County Chamber of Commerce, Atlanta Fed President Dennis Lockhart had this to say about reading the inflation data:

"To achieve price stability, policymakers must detect inflation in its early stages before it is firmly established, especially in the psychology of consumers and businesses. This early detection is a challenge because inflation is not easily measured in the short term with any precision. No single price statistic enjoys a sufficient vantage point from which to assess inflation in the short term. With imperfect tools, inflation is more easily monitored than precisely measured."

The research department of the Federal Reserve Bank of Atlanta has taken pretty seriously the task of monitoring inflation developments. Where there are gaps in our information, we've been working to fill them with data, and we've aggregated it all into one place: the Inflation Project web page.

On the Inflation Project, we now report a sticky-price CPI statistic calculated from consumer price index data using only those components whose prices are slow to change. Joint research with the Cleveland Fed has shown this measure to be helpful when thinking about inflation expectations. Using Treasury Inflation-Protected Securities data, we now produce a weekly measure of the probability of a sustained deflation. And come January 27, we'll begin reporting the results of a monthly survey of business inflation expectations that examines firms' price-setting environment and the pricing pressures they face. From the responses, we'll generate a monthly measure of respondents' year-ahead unit cost expectations.

But of course, there are already a lot of data to keep an eye on. To make it a little easier to gain some perspective, we're also unveiling our inflation dashboard. The dashboard provides a platform for visualizing some of the data we commonly monitor to keep abreast of emerging inflation developments. It tracks 30 data series grouped into six major categories—retail prices, inflation expectations, labor costs, producer prices, material and commodity costs, and money and credit.

Our data and the inflation dashboard are available on the Inflation Project web page. Let us know what you think.

Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

Nicholas Parker, economic research analyst, all with the Atlanta Fed

In the interest of precision

As you may have heard, the minutes of the December 13 meeting of the Federal Open Market Committee (FOMC) contained the news that, starting with this month's meeting, committee members will be jointly publishing not only their personal projections for gross domestic product growth, unemployment, and inflation, but also the monetary policy assumptions that underlie those forecasts. In an article published earlier this week, the enhancement to these projections, known as the Summary of Economic Projections (SEP), was described in the Wall Street Journal this way (with my emphasis added):

"Federal Reserve officials this month will begin detailing their plans for short-term interest rates, a move that could show that the central bank's easy-money policies will remain in place for years and give the economy a boost."

A similar description appeared in the Journal yesterday (again, emphasis added):

"The Fed has just taken a historic step towards increasing its transparency and accountability by saying it will begin to release interest-rate projections several years out at the conclusion of its next policy meeting on Jan. 25. This means Fed officials will soon let the world know exactly what path they believe interest rates will follow—and they, after all, set the path of interest rates."

I added the emphasis in both of those passages because I think the highlighted language isn't quite right. Here is the actual language that appears in the FOMC minutes:

"In the SEP, participants' projections for economic growth, unemployment, and inflation are conditioned on their individual assessments of the path of monetary policy that is most likely to be consistent with the Federal Reserve's statutory mandate to promote maximum employment and price stability, but information about those assessments has not been included in the SEP.…

"… participants decided to incorporate information about their projections of appropriate monetary policy into the SEP beginning in January. Specifically, the SEP will include information about participants' projections of the appropriate level of the target federal funds rate in the fourth quarter of the current year and the next few calendar years, and over the longer run; the SEP also will report participants' current projections of the likely timing of the first increase in the target rate given their projections of future economic conditions."

The minutes are pretty clear about what this information is intended to convey…

"Most participants agreed that adding their projections of the target federal funds rate to the economic projections already provided in the SEP would help the public better understand the Committee's monetary policy decisions and the ways in which those decisions depend on members' assessments of economic and financial conditions."

…and what it is not intended to convey (here too, emphasis added):

"Some participants expressed concern that publishing information about participants' individual policy projections could confuse the public; for example, they saw an appreciable risk that the public could mistakenly interpret participants' projections of the target federal funds rate as signaling the Committee's intention to follow a specific policy path rather than as indicating members' conditional projections for the federal funds rate given their expectations regarding future economic developments. Most participants viewed these concerns as manageable…"

In fact, the first Journal piece mentioned above does document some of the expressed concerns near the end of the article. For example:

"… some might mistakenly see the forecasts as an ironclad commitment, rather than a projection that could change as economy evolves."

That caveat does speak to concerns of some FOMC participants that the projections would establish a specific policy path. But the issue is about more than maintaining flexibility in the face of changing economic conditions. The broader point is that the new information in the SEPs, according to the minutes, is not intended to be a device for signaling the policy path that the FOMC, by official vote, intends to pursue.

This may seem like a small detail. But when it comes to the central bank's communications tools, even the small details matter.

By Dave Altig, senior vice president and research director at the Atlanta Fed

 

In search of an agenda for job creation

In a macroblog post yesterday, Dave Altig, research director at that Atlanta Fed, discussed some recent research from the Federal Reserve Bank of Cleveland focused on the relationship between uncertainty and job creation by small businesses. That research, which is based on survey responses from members of the National Federation of Independent Businesses (NFIB), found that a high degree of uncertainty was correlated with a scaling back in hiring plans.

Yesterday's macroblog post also delved into the connection between small business hiring plans and actual job creation, pointing out that this connection requires further examination because job creation has not, contrary to popular conversation, been a broad characteristic of the population of small businesses. Instead, it has tended to be young businesses (and especially businesses less than seven years old) that account for most of the job creation. Most young businesses are small, but relatively few small businesses are young.

I believe that understanding the job creation challenges we currently confront may require that we increasingly turn our attention to the factors restraining the high growth sectors of the economy. Some evidence from this segment of the business universe came from a recent poll of fast-growing firms that the Kauffman Foundation conducted at the Inc. 500/5000 conference in September. This table summarizes the results of that poll, which are juxtaposed with roughly comparable responses from the NFIB survey.

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The interesting thing about the Kauffman survey is that the overwhelming problem reported by those companies that are in growth mode is the inability to find qualified workers. That observation is important because it bears on such questions as: To what degree is our elevated unemployment rate structural? How do we explain the observation that the number of unemployed workers appears to be elevated relative to the number of reported job vacancies? and so on.

It is obviously not appropriate to extrapolate from a single snapshot of a sample of fast-growing firms to the U.S. economy as a whole—and that is not the message here. But it is increasingly clear that the search for a single smoking gun that will clarify what is happening in labor markets is likely to be a hopeless quest. The answer to the question asking what a jobs agenda would look like is like your Christmas wish list: one size probably does not fit all.

Note: Today's macroblog post is the last for 2011. Look for macroblog's return in early January.

John Robertson, vice president and senior economist in the Atlanta Fed's research department