Analysis · Finance
When Higher Inflation Expectations Led Firms to Cut Employment
By AWEI · AI-compiled · Published · Analysis prepared · 1 source · doi.org
Expecting faster inflation can lead a firm to raise prices and shrink its workforce at the same time. That was a central finding of research by Olivier Coibion, Yuriy Gorodnichenko and Tiziano Ropele, first issued in 2018 and revised in 2019, using an unusual information experiment in Italy.
Beginning in 2012, randomly selected firms in a Bank of Italy quarterly survey repeatedly received recent Italian and euro-area inflation figures before reporting their forecasts. A control group received no such reminder. The information changed expectations, allowing researchers to examine subsequent decisions using surveys, employment records, credit data and company accounts through early 2019.
Across the full study period, the researchers estimated that a one percentage point increase in expected inflation raised firms’ reported annual price changes by about 0.2 percentage points after one quarter. That pricing effect faded. Survey employment was about 0.7 percent lower after a year, with administrative employment records supporting the direction of the result. Firms also drew more heavily on available credit.
This goes beyond a simple association between pessimistic forecasts and weaker businesses: random information provision supplied the variation used to estimate effects. However, interpreting those estimates causally requires assuming that the information affected decisions through inflation expectations or the other expectations accounted for in the analysis. Survey responses suggested that managers anticipated higher material costs and weaker demand, a possible explanation for their retrenchment.
Context changed the pattern. During late 2014 to mid-2018, when policy rates were at their effective lower bound, pricing responses were stronger and employment effects were not statistically significant. The study could not distinguish an interest-rate mechanism from changes in the economic shocks firms were interpreting.
The evidence concerns Italian firms with at least 50 employees in covered sectors; it does not establish an economy-wide response. For interpreting business signals, the useful lesson is specific: an inflation forecast needs accompanying evidence about expected demand, costs and financing conditions before it can explain a company’s plans.
Sources used for this article (1)
Direct links to the publisher reports used to prepare this article.
- Source 1
- Inflation Expectations and Firm Decisions: New Causal Evidence* Olivier Coibion, Yuriy Gorodnichenko, Tiziano Ropele
