As the economy continues to recover from the pandemic, a combination of strong demand, severe supply disruptions, widespread labor shortages, and surging energy prices has contributed to a rapid increase in inflation. Indeed, the inflation rate, as measured by the Consumer Price Index (CPI), has exceeded 8 percent over the past year, the fastest pace of price increase since the early 1980s. If businesses and consumers expect inflation to be high in the future because it is elevated today, they may change their behavior accordingly, which can make inflation even more persistent. In other words, expectations about the path of future inflation can affect how current inflation will actually evolve. In particular, among businesses, expectations about future inflation can shape how they set wages and prices. Our May regional business surveys asked firms what they expected inflation to be one year, three years, and five years from now. Responses indicate that while businesses, like consumers, expect high inflation to continue over the next year, such elevated levels of inflation are not expected to persist over longer time horizons.
Businesses See Inflation Moderating
A common way to gauge inflation expectations is to ask households about the path of future price increases. Indeed, our Survey of Consumer Expectations has long asked people about their outlook for inflation. Businesses, however, can offer a valuable perspective on inflation expectations because they regularly negotiate employee wages and set the prices of the goods and services they provide—precisely the kinds of business decisions that can be affected by expectations of high future inflation. In fact, recent research suggests that the expectations of businesses tend to be more predictive of actual inflation than the expectations of households.
Our May Empire State Manufacturing Survey and Business Leaders Survey included questions posed to regional businesses about their inflation expectations. When queried about their expectations over the next year, businesses generally expect inflation—as measured by the change in the CPI—to remain on the high side. As the chart below shows, the typical manufacturer expects prices to rise by 6.5 percent in the year ahead and the typical service firm expects inflation to be 6.1 percent over the next twelve months. These short-term expectations are only modestly lower than the actual inflation rate over the past year. However, when asked about inflation expectations over the medium-to-long term (three to five years ahead), businesses in both surveys expect price increases to moderate to 4 percent in 2025 and 3 percent in 2027. Interestingly, inflation expectations among businesses in the region line up quite well with the inflation expectations of households obtained by our nationwide Survey of Consumer Expectations.
Median Inflation Expectations among Businesses and Consumers, May 2022
How much consensus is there among businesses on the path of future inflation? Our survey finds that firms’ inflation expectations exhibit fairly wide dispersion one year ahead, but tend to converge at longer time horizons. In particular, the inter-quartile range for one-year expectations—that is, what the middle 50 percent of respondents expect—is 5 to 10 percent among manufacturers and 5 to 8 percent for service firms, but narrows to 2 to 4 percent for both kinds of businesses five years out.
Consistent with evidence from household surveys, our regional business surveys indicate that firms’ expectations about inflation a few years out tend to be significantly lower than the current rate of inflation. This pattern of inflation expectations suggests that both businesses and consumers view the current period of high inflation largely as a consequence of the unusual economic environment. Thus, despite high current inflation, inflationary pressures are not expected to persist once economic conditions stabilize.
Jaison R. Abel is head of Urban and Regional Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.
Jason Bram is an economic research advisor in the Bank’s Research and Statistics Group.
Richard Deitz is an economic research advisor in the Bank’s Research and Statistics Group.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.