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June 08, 2023: Davud Rostam-Arschar (Uni Mannheim)

Followers or Ignorants? Inflation Expectations and Price Setting Behavior of Firms

Using a customized firm survey and randomized experiment, we investigate how firms’ inflation expectations shape their price setting. Consistent with Calvo pricing, we establish that firms fully pass through inflation expectations to prices in times of high inflation. When informed about central bank inflation forecasts, firms indicate plans to increase prices by 22% less than their untreated peers. In addition, treated firms pass through less of their pre-treatment inflation expectations than control-group firms. When receiving additional central bank forecasts on energy and labor cost developments, the updating of passthrough is even stronger. This suggests that inflation forecast communication shifts expectations and prices and can be an effective policy tool.