The Covid-19 shock is unprecedented in its origin and impact. Seen through the lens of macroeconomics, the spread of the epidemic and the measures adopted to counter it have led to an unusual and simultaneous sharp fall in both supply and demand. Scholars have debated extensively the impact of this shock on firms' pricing behaviour, which is difficult to predict due to its exceptional features but is of utmost importance as Covid-19 struck the US and euro area economies in the context of a persistently low inflation environment.
The debate has mainly focused on the prevalence of the demand versus supply channels, or on the ties between them (Baqaee and Farhi 2020, Bekaert et al. 2020, Brinca et al. 2020, del Rio-Chanona et al. 2020). A theory of Keynesian supply shocks has emerged (Guerrieri et al., 2020) where temporary supply shortages that asymmetrically affect different sectors of the economy trigger a contraction in aggregate demand that is even larger than the original shocks themselves, leading to deflationary pressures.
Empirical evidence to gauge directly how firms perceived this type of shock and its impact on their expectations and pricing policies is scarce, reflecting the lack of data on companies’ behaviour and expectations. Two exceptions are Balleer et al. (2020) on German firm-level survey data and Balduzzi et al. (2020) on Italian firms.
In our recent work (Bottone et al., 2021), we provide a full characterisation of the impact of the Covid-19 shock on firms' pricing behaviour using a unique dataset, the quarterly Bank of Italy’s Survey on Inflation and Growth Expectations (SIGE),1 which has included ad-hoc questions since the wave carried out in March 2020, soon after the outbreak of the epidemic in Italy.
Survey design and Covid-19 special questions
Beyond assessments and expectations relating to the general economic situation and firms’ specific conditions, SIGE includes quantitative questions on firms’ consumer inflation expectations over different horizons and on the planned change in firms’ product prices over the next 12 months. Firms are also asked to quantify the role of several factors in influencing their pricing strategies, among which is attention paid to their competitors’ pricing policies. Our analysis uses the four waves conducted in 2020, during different phases of the pandemic in Italy. In March, June, and September 2020, firms were also asked about the channels through which the epidemic affected their activity. A clear-cut result emerges (see Figure 2) – from the very beginning of the epidemic, the majority of firms perceived it as a demand shock and this perception has remained robust over time, as also shown by the June and September surveys.2 For about 50% of companies, Covid-19 impacted their business mainly through the domestic demand channel. Foreign demand also played an important role, especially in the early stages of the pandemic, while the share of firms perceiving Covid-19 as a supply or financial shock represents only about 20% of the population.
Figure 1 Main transmission channels for Covid-19
Source: SIGE data.
Notes: Each bar represents the share of respondents for each option. Each participant could choose only one option, so the sum of the bars in each quarter adds to 100. This question was not included in the December 2020 wave.
Starting from the June 2020 wave, firms have been asked how many months they think it will take to return to their pre-epidemic business levels, thus providing a measure of the expected persistence of the Covid shock on their activity. Figure 2 shows that the large majority of firms perceived Covid-19 as having a long-lasting impact on their activity and that the average time needed to recover lengthened somewhat over time. A small percentage of businesses thought that the Covid shock would have permanent effects on their activity.
Figure 2 Perceived shock persistence
Source: SIGE data.
Notes: Left panel shows the distribution of responses to the qualitative question on time needed to return to normality. Right panel shows the kernel distributions of the exact number of months indicated by firms answering “some months needed".
We estimate several specifications to identify the drivers of firms’ pricing policies and inflation expectations during the pandemic. Our main results can be summarised as follows. Perceiving Covid-19 as a demand or supply shock has no significant impact on firms’ pricing strategies nor on their inflation expectations. The significant drivers of firms’ planned price changes are instead the perceived persistence of the Covid-19 impact on firms’ business activity and the strength of competitive pressures. The longer the time deemed necessary to return to their normal business levels and the greater the attention paid to their competitors’ pricing policies, the more likely firms are to reduce their product prices. Firms’ inflation expectations, instead, vary negatively with the expected persistence of the Covid-19 effects on the general economic situation.
The long history of SIGE also allows us to compare the response to the Covid-19 shock with those in previous recession episodes. First, we examine the role of liquidity and financial constraints, which have identified by the literature as relevant drivers of corporate pricing policies during the Great Recession and the sovereign debt crisis. Our findings suggest that in this respect, the pandemic crisis is very different from previous ones. Most firms continued to report an appropriate liquidity situation over the 2020 survey waves (see also De Socio et al. 2020) and, more importantly, liquidity and financial conditions are found not to have influenced pricing decisions during the pandemic. This might reflect the exceptional fiscal and monetary responses, which prevented the pandemic crisis from morphing into a financial crisis.
Second, again differently from what happened in the wake of the Lehman collapse and the sovereign debt crisis, the revisions of one-year-ahead inflation expectations with respect to the round preceding the pandemic shock are quantitatively muted and concentrated around zero, with half of the firms revising upwards and half of them downwards (Figure 3). Arguably, the complexity of this shock meant firms were highly uncertain about its inflationary implications – just as the markets, analysts and academics were – entailing only a marginal revision to their inflation expectations.
Figure 3 Firms’ inflation expectations and their revision
Source: Authors' calculations on SIGE data.
Note: The left column plots the distribution of the 12-month ahead in inflation expectations while the right column their variation with respect to the previous round. The red vertical line represents the value of the inflation treatment (i.e. the last available realized figure for Italian inflation) in the corresponding quarter whereas the blue dashed line represents the variation in the information treatment between two consecutive rounds.
Balduzzi, P, E Brancati, M Brianti, and F Schiantarelli (2020), “The Economic Effects of COVID-19 and Credit Constraints: Evidence from Italian Firms' Expectations and Plans," Boston College Working Papers in Economics 1013, Boston College Department of Economics.
Balleer, A, S Link, M Menkhoff and P Zorn (2020), “Demand versus supply: Price adjustment during the Covid-19 pandemic”, VoxEU.org, 27 July.
Baqaee, D and E Farhi (2020), “Supply versus demand: Unemployment and inflation in the Covid-19 recession”, VoxEU.org, 29 June.
Bekaert, G, E Engstrom, and A Ermolov (2020), “Aggregate Demand and Aggregate Supply Effects of COVID-19: A Real-time Analysis," Finance and Economics Discussion Series 2020-049, Board of Governors of the Federal Reserve System.
Bottone, M, C Conflitti, M Riggi and A Tagliabracci (2021), “Firms’ inflation expectations and pricing strategies during Covid-19”, Questioni di Economia e Finanza, Bank of Italy Occasional Paper no. 619.
Brinca, P, J B Duarte and M Faria e Castro (2020), “Decomposing demand and supply shocks during COVID-19", VoxEU.org, 17 June.
del Rio-Chanona, R M, P Mealy, A Pichler, F Lafond, and D Farmer (2020), “Supply and demand shocks in the COVID-19 pandemic: An industry and occupation perspective," Papers 2004.06759, arXiv.org.
De Socio, A, S Narizzano, T Orlando, F Parlapiano, G Rodano, E Sette, and G Viggiano (2020), “The effects of the COVID-19 shock on corporates' liquidity needs, balance sheets and riskiness," Covid note, Bank of Italy.
Guerrieri, V, G Lorenzoni, L Straub and I Werning (2020), “Viral recessions: Lack of demand during the coronavirus crisis”, VoxEU.org, 6 May.
1 The survey addresses firms in the industry, non-financial private services and construction sectors with 50 or more workers. The sample consists of about 1,500 firms.
2 This evidence could be partly affected by the composition of our sample, which disregards small service firms such as bars, restaurants and small hotels, being made up of firms with at least 50 employees, which could potentially have indicated “supply" as the main transmission mechanism. Yet, the percentage of firms who choose “demand” is similar among those who could remain open and those forced to be closed by government restrictions. In addition, firm's size and geographical area do not play a crucial role, while the exposure to foreign demand slightly increases the likelihood of selecting the demand channel.