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February 22, 2012

Weighing the risks to the inflation outlook: Two views

The Federal Reserve Bank of Atlanta's Survey of Business Inflation Expectations released earlier today showed a continuation of rather modest expectations for unit cost pressures over the coming 12 months. In February, our panel of firms reported a 1.9 percent average expected rise in unit costs over the coming year, still within the very narrow 1.8 percent to 2 percent range the group has been reporting over the past five months.

Expected change in unit costs over next 12 months

That's the good news. Now for some (potentially) bad news. In a special question this month, we asked the panel to weigh in on their expectations for annual unit cost increases over the longer term—specifically, the next 5 to 10 years. The group's expectation was a percentage point higher, at 2.9 percent.

The reason for the higher expectation for unit costs over the longer term can be seen in the following chart, which compares how the group assigns probabilities to unit cost changes over the next 12 months to how they judge these probabilities over the longer term.

Distribution of respondent expectations for unit costs over next 12 months and next 5 to 10 years

In both instances, the Atlanta Fed's Business Inflation Expectations panel of firms puts the greatest likelihood that unit costs will rise in the 1 percent to 3 percent range—in a range that matches the Federal Open Market Committee's longer-term inflation objective.

But how does the group assess the risks around that increase? Over the short term, the panel sees a higher likelihood that unit costs may fall short of the 1 percent to 3 percent range. Specifically, the group sees a 36 percent chance that unit costs will rise less than 1 percent compared against only a 26 percent chance that they will rise above 3 percent. Yet when sizing up the next 5 to 10 years, the group sees only a 15 percent chance that unit costs will rise less than 1 percent per year compared with a 46 percent chance that costs will rise by more than 3 percent.

What our panel of firms appears to be telling us is that the risks to the inflation outlook—in both the near term and longer term—aren't particularly balanced. In the near term, they weigh the inflation risks more heavily to the downside. But looking over the next 5 to 10 years, the panel sees the inflation risks leaning decidedly to the upside.

What we can't tell from these data is whether the panel's assessment of the inflation risks is different today than it was before. After all, this is the first time we've asked the question, but you can bet it won't be the last.

Mike Bryan Mike Bryan, vice president and senior economist,



Laurel Graefe Laurel Graefe, economic policy analysis specialist, and



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

February 22, 2012 in Business Inflation Expectations, Data Releases, Inflation | Permalink

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Comments

First of all, I came across this blog and had to blink a couple of times. Had no idea that any entity within the FED system actually had its own blog. What a concept - excellent from a transparency perspective. As a Brit, I wish the BOE would do something similar. It sounds like overall the worries are deflation in the short-term, inflation longer-term. As a non-economist, non-central banker, I wonder if the 5-10 year higher inflation estimate has to do with a worry that some of the money from QE might leak out into the economy, or is it something different? Probably a stupid question, but every time one reads about QE one sees these overwrought articles that inevitably talk about "hyperinflation" or the like, which I do know enough of to understand this is stupid. BTW, for anyone interested, the Daily Telegraph notes that the BOE now owns ONE THIRD of all Gilts outstanding - is this a normal situation for a central bank?

Posted by: investment in farmland | February 22, 2012 at 04:12 PM

is it obvious that a realized uptick in ULCs would be associated with higher inflation rather than lower profits?

http://www.econbrowser.com/archives/2012/02/the_2012_econom.html

Posted by: john | February 23, 2012 at 08:54 AM

How valid are these panel forecasts? How much history do you have of them?

Posted by: GregL | February 26, 2012 at 08:14 AM

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