Improvement in the Outlook? The BIE Panel Thinks So

Earlier this month, Dennis Lockhart, the Atlanta Fed’s top guy, gave his assessment of the economy and monetary policy to the Kiwanis Club of Birmingham, Alabama. Here’s the essential takeaway:

There are encouraging developments in the economy, to be sure, but the evidence of sustainable momentum that will deliver “substantial improvement in the outlook for the labor market” is not yet conclusive. ... How will I, as one policymaker, determine that the balance has shifted and the time for a policy change has come? Well, one key consideration is the array of risks to the economic outlook and my degree of confidence in the outlook.

To help the boss assess the risks to the outlook, we reached out to our Business Inflation Expectations (BIE) panel to get a sense of how they view the outlook for their businesses and, notably, how they assess the risks to that outlook. Specifically, we asked:

Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to UNIT SALES LEVELS over the next 12 months.

The table below summarizes the answers and compares them to the responses we got to this statement last November.

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First, the business outlook of our panel has improved decidedly since last November. On average, our panel sees unit sales growth averaging 1.8 percent. OK, not a spectacular number, but, to our eyes at least, much improved from the 1.2 percent the group was expecting when we queried five months ago.

And how about the assessment of the risks President Lockhart indicated was also a key consideration? Here again, the sentiment in our panel appears to have shifted favorably. Last November, our panel put the likelihood that their year-ahead unit sales growth would be 1 percent or less at 50 percent. The group now puts the chances of a downshift in business activity at 37 percent. Meanwhile, the upside potential for their sales has grown. Last November, the panel put the chances of a “significant” improvement in unit sales at about 20 percent; this month, the group thinks the likelihood is 30 percent.

And this improved sentiment isn’t centered in just a few industries—it’s spread across a wide swath of the economy. Firms in construction and real estate, which were, on average, projecting 12-month unit sales growth of 1.1 percent last November, now put that growth number at 1.8 percent. The average sales outlook of general-services firms has risen from 1 percent to 2.2 percent; finance and insurance companies went from 0.5 percent to 1.3 percent; and retailers/wholesalers’ unit sales projections rose from 1.5 percent to 2 percent. And manufacturers, who posted relatively strong expectations last November, reported about the same sales outlook this month as they did five months ago.

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To be clear, President Lockhart’s recent comments—and the Federal Open Market Committee statement on which they are based—indicate he is looking for a substantial improvement in the outlook for the labor market, not sales. But we’re going to assume that it’s unlikely to have one without the having the other. And is our panel’s unit sales forecast “substantially” improved? Well, what constitutes “substantial” is in the eye of the beholder, but if this isn’t a substantial improvement in the outlook, it’s certainly a move in that direction.

By Mike Bryan, vice president and senior economist, and

Nick Parker, economic research analyst, both in the Atlanta Fed’s research department

Rose-Colored Glasses Make the Future Look Blurry: Sales Uncertainty as Seen by the November BIE

Uncertainty is widely cited as being a significant contributor to the economy's subpar growth. Reddy and Thurm report in yesterday's Wall Street Journal that "half of the nation's 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next," in large measure because of rising economic uncertainty. But how uncertain is the current economic outlook? A few economists have attempted to measure business uncertainty, often by using the degree of disagreement between various forecasts, the volatility of certain economic indicators, or some combination of the two. (Two such approaches can be found here and here.)

We thought we'd use our Business Inflation Expectations (BIE) survey to see if we could gauge the degree of business uncertainty directly. Last week, we asked our panel to assign probabilities to various sales outcomes for their businesses for the coming year. (This methodology is the same one we have been using to measure inflation uncertainty, except in this case our business panel was asked to reveal their expectations for unit sales growth over the year ahead.)

Specifically, we put to our panel the following statement:

Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to unit sales over the next 12 months.

Panelists were given the following five unit sales outcomes:

1. down (less than –1 percent)
2. about unchanged (–1 percent to 1 percent)
3. up somewhat (1.1 percent to 3 percent)
4. up significantly (3.1 percent to 5 percent)
5. up very significantly (greater than 5 percent)

One hundred and ninety-four businesses responded, and here's what they told us: On average, firms expect unit sales growth of about 1.2 percent in the coming year. That's more pessimistic than the real gross domestic product (GDP) forecast of the consensus of economists for the year (about 2 percent). But the range of possible outcomes seemed, to our eyes a least, to be large and unbalanced.

Consider the chart below, which shows the probabilities the panel, on average, assigned to the various sales outcomes. They assigned a 48 percent chance that their unit sales will grow 1 percent or less in the coming year, balanced against only 23 percent likelihood that unit sales will grow more than 3 percent over the next 12 months. In other words, in the minds of our BIE panel, the range of likely sales outcomes over the year ahead is pretty wide, with a fairly weighty chance that unit sales growth may not move in a positive range at all.

Perhaps we are making a bit too much of the size of the uncertainty businesses are attaching to the outlook. After all, we don't know what uncertainties firms face even in the best of times (since this is the first time we've asked this question). But when we dug into the data a little deeper, we found something else of interest. The degree of economic uncertainty varies widely by firm. Moreover, the greatest uncertainty about the future was held by the panelists who have the most optimistic sales outlook.

Check out the table below. It shows the degree of sales forecast uncertainty on the basis of whether a firm's sales projection is high or low.

Panelists with the most optimistic sales expectations (the 39 firms with the highest sales forecasts) predicted unit sales growth of a little more than 3.5 percent this year, compared with about a 0.5 percent decline in unit sales for the 39 most pessimistic panelists. But also note that those who are relatively optimistic about the coming year have much greater uncertainty about their future than those who are relatively pessimistic—in fact, they're almost twice as uncertain.

What the November BIE survey seems to be saying is that it isn't just that an uncertain business outlook is reining in our growth prospects, but that the outlook is especially uncertain for the firms that think they have the best opportunity for expansion. Apparently, those wearing rose-colored glasses are having trouble seeing through them.

Note: The regular November Business Inflation Expectations report will be released Wednesday morning.

By Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

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

 

How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey

Opinions vary widely about how much slack there is in the economy these days. Some say a lot—some say not so much.

Last month, we reached out to members of our Business Inflation Expectations (BIE) panel for their take on the issue. The panel indicated they had more pricing power in August than they did last October. OK, that doesn't exactly gauge the amount of slack businesses think they have, but it does suggest that, however much slack there is, it's been shrinking.

Another detail revealed by our August inquiry was that retailers think they have more pricing power compared with manufacturers—a pretty good sign the latter is experiencing more slack than the former.

In this month's BIE survey we went fishing in the same murky waters, but this time we took a more direct approach. We asked our panel to provide a percentage estimate of how far their sales levels are above/below "normal." Here's what we found: On a gross domestic product (GDP)–weighted basis, the panel estimates that current sales are about 7.5 percent below normal. That's more slack than the conventional estimates, like the Congressional Budget Office's (CBO) measure of the GDP gap, which puts the economy about 6 percent under its potential.

But perhaps a more interesting observation from our September survey is how widely current performance varies by sector and size within our panel. Retailers, for example, say their current sales are a little less than 2 percent below normal. And firms in the leisure/hospitality and the transportation/warehousing sectors—sectors where growth has been particularly robust in recent years—say they are operating at, or just a shade above, normal levels.

Compare these estimates with those from durable goods manufacturers, which report that their current sales levels are nearly 12 percent below normal, and finance and insurance companies, which say they are almost 17 percent below normal. And construction firms? Well, best not even ask them.

And the amount of slack firms are reporting isn't just a reflection of their sector of the economy—size also matters. Firms with more than 500 employees say their current sales levels are a little less than 5 percent below normal—half as much as the amount of slack being reported by small firms.

So we're led back to the question that kicked this blog post off. How big is the output gap? Some say a lot—some say not so much. And this difference in perspective is not just among policymakers. Within the economy, experience varies at least as widely; some firms' sales are still well below normal, while others are telling us that they are very nearly back to normal, and some are already there.

But here's the rub. If the economy represents a constellation of firms operating at widely varying levels of capacity, from what viewpoint should we consider the economy relative to its potential? Are aggregate measures, like the one provided by the CBO or by our "GDP-weighted" approach, appropriate perspectives? Indeed, given widely varying measures of economic performance across firms and industries, how meaningful is an aggregate assessment of economic slack?

Ah, we'll leave these questions for the November survey.

By Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

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

 

Do Firms Have Pricing Power?

Here's a question every policymaker would like to know the answer to: How much slack is there in the economy? You know the drill: If there's lots of slack, firms have little power to pass cost increases on to customers. But as the economy approaches full employment, the pricing power of firms strengthens, and cost pressures get more readily passed along. The problem is, there doesn't seem to be any practical consensus about the amount of slack in our economy. To paraphrase a well-known adage widely attributed to Nobel Laureate Ronald Coase, we've been torturing the Phillips Curve, but it isn't talking.

We wondered if businesses might be in a better position to say what kind of pricing power they have. So this month we asked our Business Inflation Panel to weigh in on how they might adjust their prices in the face of a hypothetical, unanticipated increase in costs. Not knowing what kind of cost pressure a firm might respond to, we randomly sorted our panel into two groups—one given a 2 percent cost-increase scenario, and one given a 6 percent cost-increase scenario. Here's what we learned:

On average, firms faced with the 2 percent cost increase were likely to pass about 1.3 percentage points (or 66 percent) to their customers. In the portion of our panel considering the 6 percent cost increase, the average impact on customer prices was 3.8 percentage points (or about 63 percent of the cost increase). So in the aggregate, firms think they can pass about two-thirds of any cost increase through to prices, and that belief holds roughly true whether the cost increase is relatively modest or somewhat large.

We asked a similar question of our panel last October, but the responses we got then indicated that firms held a more conservative view of their pricing power.

Of the firms facing the 2 percent cost-hike scenario last October, only 31 percent said they would pass along most of the cost on to their customers, compared with the 53 percent that said they would do so today (see the chart above).

Likewise, of the panelists asked to consider a 6 percent cost increase, only 37 percent said they would pass most of the increase on to customers last October, compared with 60 percent who said they would do so today (see chart above).

What's behind the reported increase in firms' pricing power since October? Well, we'd be speculating on that point, but one thing that's changed since October is that a smaller proportion of firms are reporting sales levels “less than normal” (54 percent compared with 64 percent in October). Said another way, firms, in the aggregate are reporting less slack today than they were ten months ago—a finding that aligns with recent results from the NFIB small business survey showing a decrease in the percentage of firms that consider poor sales to be the primary issue they face.

Comparisons across industry groups also suggest that slack may be influencing firms' reported pricing power. Retailers, for example, say they would pass through about 75 percent of a cost increase to their customers, compared with only 64 percent for manufacturers and 60 percent for other firms. At the same time, retailers are reporting that sales and price margins are closer to normal—a sign that their perception of “slack” is not as great as other firms.

Does the analysis above indicate that firms are running out of slack? Sorry, but we can't quite go that far on the basis of these two surveys. But one thing seems clear—while our panel of businesses says sales levels are still below normal, sales and pricing power are better today than they were last October.

By Mike Bryan, vice president and senior economist;

Laurel Graefe, economic policy analysis specialist;

Nicholas Parker, economic research analyst; and

Kate Rees, economic research analyst, all with the Atlanta Fed

Do falling commodity prices imply disinflation ahead?

Cost pressures at the manufacturing level appear to be easing—at least, so say the manufacturers in our Business Inflation Expectations survey. In June, manufacturers reported that unit costs were up only 1.3 percent over the last 12 months, a full percentage point below their assessment at the end of last year. Retailers, on the other hand, report unit cost increases of 2.1 percent, down a bit from May, but 0.3 percentage points higher than in December.

We put a special question to our panel in June that may shed a little light on these patterns. When we asked firms to tell us what has been driving their unit costs over the past 12 months, manufacturers saw considerably less pressure coming from their cost of materials compared with other firms. Perhaps this discovery isn't very surprising. After all, commodity prices have been falling pretty sharply of late, and these costs are especially influential to manufacturers' assessment of the cost environment. (Indeed, in response to a special question we asked our panel in March, manufacturers ranked materials costs as the number-one influence on their pricing decisions.)

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Does the fall in commodity prices mean we can expect a pass-through of these lower costs to consumers?

Perhaps. There's certainly a strong intuitive appeal to the "pipeline" theory of inflation. Here's the idea as described by the Bank of England (BOE):

"Consumer prices…can be thought of as the end of a 'pipeline' of costs and prices. The final price will be made up of many different components of cost as well as the retailer's profit or margin… Prices at one stage of the pipeline become costs for the next stage…"

But economists who have looked down the inflation pipeline haven't found flows, but rather trickles. Years ago, Todd Clark of the Cleveland Fed put it this way while he was at the Kansas City Fed: "the empirical evidence… shows the production chain only weakly links consumer prices to producer prices."

So the "inflation pipeline" theory isn't that simple, as the BOE goes on to explain:

"The [pipeline] idea is a simplification… Prices are determined by the interaction of supply and demand. If the cost of raw materials rises, for example, producers or retailers might accept lower profit margins rather than raise their prices. They are more likely to do this if demand is weak or because of competition. The degree of competition in markets can affect how much cost increases are passed on to consumers."

Investigations into what might be obstructing the flows through the inflation pipeline have taken several approaches, including the one suggested by the BOE above: Firms may vary their markups (or margins) to damp the influence of costs on prices as they pass from one stage of production to the next. This idea has become a cause célèbre in macroeconomics and a key element of something called the New Keynesian Phillips Curve.

And so we've been keeping our eyes on how our panel assesses their margins, and we note something pretty striking. That is, margins are rising, but primarily for retailers. Indeed, as our panel sees it, retail margins are getting pretty close to returning to normal. Manufacturers, however, still see their margins as well below normal.

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Expanding margins, then, may slow the flow of falling commodity prices through the inflation pipeline. Manufacturers may take the fall in commodity prices as an opportunity to improve their woeful margins. And if they do pass these cost savings on down the production chain, it still might not hit consumers' wallets if retailers continue to increase their margins. (Based on our survey, that's what seems to have been going on lately, anyhow.)

For other insights from the June Business Inflation Expectation survey, see the Inflation Project on our website.

By Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

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

Symmetric goals, asymmetric risks

Mark Thoma has been hanging out with my boss or at least was at the same conference, where Thoma had a chance to try out his reporter chops:

"I just got out of a press conference with Dennis Lockhart (Atlanta Fed president) and Charles Evans (Chicago Fed president). I can't say there was any real news, but I did manage to ask a question... I asked whether the 2% inflation target was truly symmetric."

Thoma got an answer, though seemingly not one that left him totally convinced:

"Both insisted that the target is symmetric. However, Lockhart said that we know much more about the effects of inflation than deflation, and that preventing deflation was therefore job number one (which doesn't really answer the question). He didn't explain what he is so afraid of if inflation goes up...

"Evans, while explicitly agreeing the target was symmetric, made comments that indicated that it may not be. He said the Fed has not done a very good job of communicating its tolerance around the 2 percent target, both up and down, and they need to improve. But if the target is really symmetric, simply saying that (along with the tolerable range) is all that is required. Talking separately about tolerance for over and under-shooting isn't needed."

Evans' and Lockhart's statements stand on their own, but we've collected some information via the Atlanta Fed's Business Inflation Expectations survey that helps me think about the Thoma question. The chart below plots the answers, collected in the February and April surveys, to the following query: "Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to unit costs per year over the next five to 10 years."

The question focuses on unit labor costs in order to elicit responses about what businesses may actually be planning for, as opposed to their guesses about a more abstract concept of overall inflation. The question focuses on expectations five to ten years into the future because the inflation goal of the Federal Open Market Committee (FOMC) is explicitly a long-run objective.

The obvious pattern in these survey responses is their asymmetry to the upside. The most probable outcome, according to the respondents, is that long-term costs will rise in a range that includes the FOMC's long-run inflation objective. But they also put an almost 50 percent probability on annual outcomes higher than 3 percent. Less than 20 percent probability is placed on costs rising at rates of less than 1 percent.

This picture is one of asymmetric risks to the inflation outlook, and as such it is an important element in thinking through policy choices. Symmetry in the sense of having an equal distaste for misses on either side of an objective does not necessarily imply symmetry with respect to the risks of meeting that objective.

To begin with, the Fed does have a dual mandate. Disinflation or, in the extreme, deflation has the potential to be problematic for growth and employment when interest rates are very low. The reason, if you buy the analysis, is that, with no room for rates to move lower, a decline in inflation raises the real cost of borrowing. A higher cost of borrowing restrains spending, creating an additional drag on economic activity in already tough circumstances.

The reverse argument has, of course, been made for temporarily tolerating inflation that is somewhat higher than the long-run objective. But even if you aren't quite sold on the wisdom of that approach—and I'll get to that in a bit—it is clear that, with policy rates near zero, misses to the downside on inflation bring risks to the Fed's growth mandate that are not implied by misses to the upside. Hence President Lockhart's comment regarding the importance of preventing deflation.

So why not respond to this asymmetric risk to growth by taking a chance on higher inflation? That question takes us back to the chart above. Taken at face value, the probabilities reported by our survey respondents suggest that the FOMC has been pretty successful in convincing folks that very low rates of inflation or deflation will not be allowed to set in. Perhaps this conviction is not surprising given the relatively aggressive responses of the committee to the disinflation scares of 2003 and 2010.

But the response to asymmetric risks to growth at low inflation rates may have had the effect of inducing asymmetric risks to the upside with respect to Fed's price stability mandate. Again taken at face value, the results of our business inflation expectations survey definitely imply a one-sided bet by businesses on how the FOMC might miss on its inflation objective. That could well explain why one would be so concerned if inflation rises. Just as there are asymmetric risks associated with below-objective inflation when it comes to the Fed's growth and employment mandate, there are asymmetric risks associated with above-objective inflation when it comes to the price stability mandate.

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

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.

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.

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, 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

Gauging the inflation expectations of business

Last Friday, the U.S. Bureau of Labor Statistics (BLS) reported that the consumer price index (CPI) declined in June for the third consecutive month. And although core inflation edged up a bit, the entire increase can be accounted for by the BLS's seasonal adjustment factor. In an environment of "business-not-as-usual" like today, data driven by seasonal adjustment are certainly suspect. So overall, the June CPI news seems largely in line with the downward inflation trend we've been seeing for a while.

Does recent disinflation imply deflation? Well, that wouldn't be the consensus coming out of the June 22–23, 2010, FOMC meeting minutes:

"A broad set of indicators suggested that underlying inflation remained subdued and was, on net, trending lower,… However, inflation expectations were seen by most participants as well anchored, which would tend to curb any tendency for actual inflation to decline."

A similar sentiment was expressed recently by European Central Bank (ECB) President Jean-Claude Trichet in describing the ECB's view on inflation expectations:

"Inflation expectations remain firmly anchored in line with our aim of keeping inflation rates below, but close to, 2% over the medium term."

Of course, how firmly something is anchored has meaning only relative to the forces working to move that anchor. Being well anchored against a five-knot drift isn't exactly the same as being well anchored against a 10-knot current. But assuming the idea here is that expectations are likely to hold against the usual range of events one might expect in an environment like ours, we can ask the question: How does one judge whether expectations are well anchored?

Presuming this analogy, one way we might gauge how anchored inflation expectations are is to monitor the behavior of inflation expectations relative to recent shocks. By this standard, expectations seem rock-solid. Virtually every measure of inflation expectations has held steady against the tug of widely fluctuating commodity prices, persistent retail disinflation, expansion of the central bank's balance sheet, large current and projected fiscal imbalances, and the general economic and financial volatility of the past few years.

But economists know very little about how expectations are formed and, therefore, we don't know what sorts of events are likely to pose the greatest threats to the expectations' anchor. In other words, we may not know when inflation expectations are likely to move until, well, they actually move.

In an attempt to get a more direct read of inflationary sentiment and to put more light on how inflation expectations are formed, the Federal Reserve Bank of Atlanta is looking into polling businesses about their inflation expectations. With help from the folks at Kennesaw State University (a very big hat-tip to Don Sabbarese and Dimitri Dodonova, who compile the Georgia and Southeast Purchasing Managers' Indexes) we asked a group of purchasing managers a handful of questions related to the inflation outlook. The poll was conducted during the week of July 7–July 13, and 32 respondents answered the call. Here's what we learned.

Over the next 12 months, this sample of purchasing managers expects unit costs to increase 1.7 percent, just a shade higher than the consensus CPI forecast of economists. The distribution of the poll responses is represented by the red bars in the chart below. About half of the respondents saw unit costs rising "somewhat" defined by the range of 2 percent to 4 percent, while about one-third of the respondents indicated they expect virtually no change in unit costs over the period.

But what probability do respondents attach to their expectations? It turns out that some respondents have great confidence in their expectation for unit cost changes—they assigned little chance that unit labor costs would do anything other than what they forecast. But most purchasing managers attached a significant likelihood to a large range of possible outcomes. We show the distribution of the average respondents' expectation for unit costs by the blue bars in the chart. So, keeping in mind that the mean expectation of the group was for unit costs to rise 1.7 percent, respondents on average assigned a 17 percent chance that unit costs could decline over the coming year, while they put an equally large likelihood of inflation at 5 percent or more (20 percent).

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What does all this mean for the inflation outlook? Well, first, let us caution that a sample of this size doesn't lend itself to any strong conclusions, and these data will have to be carefully evaluated in light of other poll questions and against other benchmarks. Those important caveats aside, we can say that while the average purchasing manager in our poll is expecting price pressures that pretty closely correspond to the Federal Reserve's long-term inflation projection, this group attaches significant upside and downside risks to the inflation outlook.

Have any thoughts about how we proceed from here? We'd love to hear your ideas. The next poll will be sent to potential respondents in about three weeks.

By Mike Bryan, vice president and senior economist, and Laurel Graefe, senior economic research analyst, both at the Atlanta Fed