VoxEU Column Monetary Policy

The inflation expectations of Italian firms

Given the role firms play in the transmission of monetary policy decisions, it is useful to understand how they form their inflation expectations. The column uses data from Italy to show that firms are attentive to the economic environment, even if they are not completely aware of the latest developments. They are also able to extract relevant information to update their expectations from ECB communications.

Euro area inflation is set on a path of sustained convergence to the ECB price stability goal: longer-term inflation expectations appear to be well-anchored (Draghi 2018). The conduct of monetary policy relies heavily on steering agents’ inflation expectations regarding the central bank’s price stability goal, even more so when we are close to the effective lower bound on interest rates, at which standard tools provide limited margins of action. 

Central banks typically monitor market expectations and those of professional forecasters, thanks both to timely available data and to the fact that they reflect the opinions of well-informed and skilled economic agents. But economic decisions are ultimately taken by households and firms. The inflation expectations of households have been extensively explored from several perspectives (Carroll 2003, Mankiw et al. 2003, Christelis et. al. 2016), but those of firms have received almost no attention due to a shortage of suitable data (Bernanke 2007). 

Given the role firms play in the transmission of monetary policy decisions, especially as price setters and wage negotiators, this is a major gap. It is also a worrisome one because the scant available evidence suggests that firms are largely unaware of nominal developments and of the policies and goals of the monetary authority and, on average, they tend to formulate unrealistic inflation expectations (Afrouzi et al. 2015).

In two recent papers (Bartiloro et al. 2017, Bottone and Rosolia 2018), my co-authors and I add to this debate by assessing:

  • the degree of anchoring of firms’ inflation expectations in the aftermath of the euro area sovereign debt crisis
  • the extent to which firms revise their inflation expectations following unanticipated monetary policy news. 

The analysis is based on the Bank of Italy’s Survey of Inflation and Growth Expectations, which uses a sample of about 1,000 industrial and service firms with at least 50 employees. The Survey has been conducted quarterly since 1999 and specifically collects firms’ point inflation expectations at several time horizons (Bank of Italy 2018). 

Evidence on the inflation expectations of firms

In Italy, the inflation expectations formulated by firms have been broadly in line with those reported by professional forecasters (Figure 1). Differences are unlikely to reflect a lack of relevant information on the firms’ side because, since the beginning of the survey in 1999, respondents were provided with the most recent inflation reading in Italy and in the euro area before they were surveyed. The difference of about a half percentage point in the first part of the period most likely reflects different degrees of learning about the new monetary framework. 

Like professional forecasters and households, Italian firms disagree about future inflation (Mankiw et al. 2003, Dovern et al. 2012, Cavallo et al. 2015, Nishiguchi et al. 2015). This disagreement is pervasive even among very similar firms, suggesting it is related to very specific firm features, experiences or information sources (Coibion and Gorodnichenko 2015, Malmendier and Nagel 2016, Binder 2018). This is indirectly confirmed by the fact that disagreement is higher when price dynamics are more differentiated across HICP items and when consumer inflation is more volatile in the short run. Also, disagreement is larger when current inflation is further away from the ECB price stability goal.

Figure 1 Inflation expectations of firms and consensus forecasts are broadly similar

Source: Dovern et al. (2012).
Note: Median 12-month ahead inflation expectations of informed firms and 12-month ahead Consensus forecasts.

The lingering risks of de-anchoring

When expectations are more anchored, agents put less weight on incoming data so that their expectations are less sensitive to current developments (Bernanke 2007). A specific feature of the Bank of Italy’s survey makes it possible to quantify the weight that price-setters place on incoming data and, in particular, on the most recent inflation reading and how it evolves over time. 

Specifically, since the beginning of the survey respondents have been made aware of current inflation before reporting their expectations. However, since the third quarter of 2012, a random subset of about one-third of respondents was not given this information. The two groups are named 'Informed' and 'Uninformed'. 

Figure 2 shows the median inflation expectations at 12 and 24 months of the two groups. Although the lack of attention to current developments does not seem to be extreme, as suggested by the fact that in both groups inflation expectations move with current inflation, firms made aware of current inflation generally revise their expectations toward that value.

Figure 2 Firms revise their expectations with information about current developments

Note: Median 12- and 24- month ahead inflation expectations of informed and uninformed firms and yearly HICP inflation rate communicated to firms in the quarter.

In a recent paper, Laura Bartiloro, Marco Bottone and I exploit the random nature of the provision of information and interpret the expectations reported by uninformed firms as the prior expectations of a hypothetical population, and those reported by informed firms as the expectations of the same population updated with incoming information (Bartiloro, Bottone and Rosolia 2017). 

We are able to show that, under a standard representation of the firms’ learning process, the ratio of the cross-sectional dispersion of the expectations of informed and uninformedfirms can be taken as a measure of the strength of prior expectations against incoming data. A joint reading of this index and the level of prior expectations offers a rough assessment of the degree of anchoring of firms’ inflation expectations. 

Figure 3 displays, for the 12- and 24-month horizons, the weight of the prior expectations (left axis) and the expectations of uninformed firms (the prior itself) and current inflation (the incoming information) (both right axis). As consumer prices quickly slowed down after the sovereign debt crisis, the weight assigned by firms to their prior expectations kept falling, implying a growing role for incoming data to help them form expectations. 

Figure 3 The relative weight of prior expectations and incoming information varies over time

Note: The weight on the prior is the ratio of the standard deviation of the expectations of informed firms to that of uninformed ones. Standard deviations are computed excluding observations in the top and bottom 1% of the cross-sectional distribution of 12-month-ahead inflation expectations.

The downward revisions seem to have stopped when current inflation stabilised at exceptionally low levels, at which point the weight given to new, lower prior inflation expectations rose again. As a consequence, the pick-up in inflation recorded since 2017 has not yet been incorporated into firms’ expectations, still hovering around 1% at both 12 and 24 months, and with a high weight in the updating process. 

It is interesting to note that, especially at the 12-month horizon, when current inflation occasionally fell below zero, the weight put on the (still positive) prior sharply increases. Similarly, when in the second quarter of 2017 inflation hit 2%, the weight on the lower prior again increases considerably. Indeed, that inflation figure turned out to be a temporary occurrence. In both cases, faced with uncommon inflation readings, firms were cautious enough not revise their expectations as suggested by their recent updating strategy. Instead they opted for a temporary revision of the strategy itself.

The response to monetary policy shocks

Firms are therefore been attentive to the economic environment, even if they are apparently not completely aware of the latest developments. They also seem to put the information provided into the proper context, as suggested by the lack of substantial updates in light of occasionally negative or unusually high inflation readings. 

The unawareness of current HICP developments may partly be because they are not relevant for all firms. Exporters may pay more attention to price developments in foreign markets, producers of intermediates may focus more on producer prices. To more thoroughly assess the degree of attention to macroeconomic developments and the ability to process incoming information, in a more recent paper Marco Bottone and I directly ask whether the inflation expectations of firms respond to unanticipated monetary policy shocks which are undoubtedly relevant to all economic agents (Bottone and Rosolia 2018). 

A confidential version of the data, which include the dates on which firms filled in the questionnaire, makes it possible to engineer a simple empirical exercise based on the comparison of the inflation expectations reported by firms interviewed in the days just before a given meeting of the ECB Governing Council to those of firms surveyed in the days just following it. These differences, one for each wave of the survey since 2002, are then related to standard market-based measures of unanticipated monetary policy news based on the daily change of major market interest rates on the days the ECB issue its decisions (Kuttner 2001, Gurkaynak et al. 2005). 

Figure 4 plots the difference in average inflation expectations at 12 and 24 months reported by firms interviewed before and after the meetings (vertical axis) against the daily change on Governing Council days of the three-months Overnight Index Swap (horizontal axis). The negative relationship shown in the figure is confirmed by empirical exercises in which unanticipated changes along the term structure were jointly considered. It appears to hold even when the effective lower bound on interest rates is binding.

Figure 4 Inflation expectations respond to unanticipated monetary policy news

Note: 1999 Q4 to 2008 Q1, only available for 12-month-ahead inflation expectations, in red.

It is obviously highly unlikely that firms themselves closely follow financial market developments on Governing Council days. More likely, the importance of the various ECB communications is conveyed through the media. The results therefore suggest that firms know which events and sources to pay attention to, and have the ability to extract relevant information to update their expectations.

Firms understand current developments

Inflation expectations of Italian firms are no longer deteriorating. Yet, persistent upward revisions require further sustained progress in moving towards the price stability goal. Reassuringly, the evidence presented here suggests that firms quickly understand developments and are rarely misled by temporary shocks. Importantly, they understand and directly respond to monetary policy decisions by revising their inflation expectations consistently with monetary policy impulses, even at times when the space for standard monetary policy tools is limited. 

Authors’ note: The views expressed in this column are those of the author and do not necessarily reflect those of the Bank of Italy.


Afrouzi, H, O Coibion, Y Gorodnichenko, and S. Kumar (2015), “Inflation targeting does not anchor inflation expectations: Evidence from a new firm survey”,, 13 October.

Bank of Italy (2018), “Survey of Inflation and Growth Expectations”, Methods and Sources.

Bartiloro, L, M Bottone, and A Rosolia (2017), “What does the heterogeneity of the inflation expectations of Italian firms tell us?”, Bank of Italy occasional papers 414.

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Bottone, M, A Rosolia (2018), “Monetary policy, firms’ inflation expectations and prices: evidence from daily firm-level data”, mimeo, Bank of Italy.

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Nishiguchi, S, J Nakajima, and K Imakubo (2015), “Disagreement about inflation expectations: The case of Japanese households”,, 2 May. 

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