Unit Cost Expectations and Uncertainty: Firms' Perspectives on Inflation

We propose a proxy for the inflation expectations of firms based on aggregating own-firm probabilistic unit cost expectations. Unlike other surveys of firms or households that elicit “aggregate†expectations, we focus on idiosyncratic costs that firms are well-aware of, plan for, and matter for price-setting. We document five key findings. First, in aggregate, firms’ unit cost expectations significantly outperform households’ inflation expectations and are at least as accurate as the expectations of professional forecasters in out-of-sample forecasting exercises. Second, once aggregated, firms’ unit cost realizations closely comove with U.S. inflation statistics. Third, utilizing a novel, flexible technique to parametrically estimate firms’ unit cost uncertainty, we find that up until early 2020, the evolution of firms’ views was similar to other survey and market-based measures of inflation uncertainty. Fourth, utilizing special questions, we find evidence that information treatments about aggregate inflation and policymakers’ forecasts do little to alter firms’ unit cost expectations. And, lastly, we show that unit costs, at the firm level, are an important determinant of their own price setting behavior.