Firm Expectations

This overview is based on the paper titled “How Do Firms Form Their Expectations? New Survey Evidence” authored by Olivier Coibion, Yuriy Gorodnichenko and Saten Kumar and is published in the American Economic Review.

Firm’s make decisions depending on their expectations of future economic conditions. This is reflected in choices relevant to wages, employment, investment and pricing of goods - which in turn affects inflation levels and employment rates.  Central banks such as the U.S. Federal Reserve and the European Central Bank set targets for both inflation and the employment rates and so it is essential to understand how firm’s incorporate news of monetary policy implementation. However, there is limited information on firms’ attitudes towards macroeconomic conditions. Expectations of inflation differ amongst different groups, and so it's important to identify how firms form their expectations and how closely this reflects central bank targets.

In our study, we surveyed an assortment of New Zealand firms about their macroeconomic expectations in order to document observations of new facts presented regarding firm beliefs. We found that expectations are often not aligned with macroeconomic conditions. Many businesses consider inflation relatively unimportant, and therefore this was not considered in their decision-making process.  There is also a lack of incentive for firms to track inflation which leads to significant misperceptions about inflation movements and forecasting. Costs due to collating macroeconomic information further support firm’s inattention in this area. Although, when firms are presented with new information, specifically negative information about inflation, they do best to adjust their beliefs and consider these factors into their decisions about investments and employment. However, this effect was not observed in decision making regarding pricing and wages as initial plans were carried through.

This study implies that macroeconomic policies which successfully affect firm’s inflation expectations are likely to have real effects on their decision-making behaviour. But effectively doing so requires strategies that communicate beyond inattentiveness and firm’s existing views on inflation. Our study highlights that as directors of economic growth, firms can benefit from considering macroeconomic policies to form clearer future expectations to support their own development.