Inflation Expectations and the Supply Chain

IMF Working Papers, August 12, 2022

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Firms rely on price changes observed along their supply chain to form expectations about aggregate inflation.
These expectations have a complete pass-through to sales prices.
Changes in prices at which firms purchase inputs inform their forecasts of the economy’s inflation, even if changes in input costs do not determine the inflation outcome.
The findings reject the full-information rational-expectations hypothesis.
Results are consistent with firms’ disagreement about future inflation and inattention to macroeconomic news, which the authors document for Chile.
A firm-level Phillips’ curve estimation suggests that firms’ beliefs about inflation are a key determinant for their price-setting decisions.
The highlighted channel has the potential to lead to dispersion in inflation expectations, price dispersion, and weaken the expectation channel of policies.

Leveraging a unique dataset on Chilean firms merging expectation surveys and records from the VAT and customs registries.
Firm-level Phillips’ curve estimation is used to link beliefs about inflation to price-setting decisions.

Dispersion in firm-level inflation beliefs can translate into price dispersion across firms.
Inattention to macroeconomic news and disagreement about inflation can weaken the effectiveness of policies that operate through the expectation channel.
Because firms pass through supply-chain price signals into sales prices, shocks to input prices can affect aggregate inflation expectations even when they do not change realized inflation.