Better central bank communication can check inflation uncertainty

Enhanced transparency and clarity in central bank communication can help mitigate inflation uncertainty and anchor inflation expectations. This is a key finding of a recent paper by the prominent think tank National Council of Applied Economic Research (NCAER).

“Firm performance across industries can provide valuable insights into expected inflation, providing policymakers with signals about future inflation trajectories,” said ‘Firm Inflation Expectations, Uncertainty and Beliefs,’ authored by Janani Rangan and Abhiman Das.

The NCAER paper focused on the dynamics between firm inflation uncertainty, inflation expectations and beliefs about their performance. It analyzed how firms’ inflation uncertainty influences their inflation expectations in India. Studying the periods before and after the Covid-19 pandemic and the Russia-Ukraine war, it found that “an increase in inflation uncertainty increases the inflation expectations of firms. This increase is accentuated by the Covid-19 pandemic. The Russia-Ukraine war period, on the other hand, has witnessed lower inflation expectations.”

The researchers explored disagreement in inflation expectations across firms, the paper said. “We observe that the disagreement has increased in the post-Covid-19 period. This is likely due to the heightened uncertainty about inflation levels and overall growth prospects. Further, our analysis of firm beliefs reveals that firms that are optimistic about their profit margins tend to have lower inflation expectations compared to those with less optimistic views about profit margins. Firms that expect an increase in profit margins may anticipate lower costs.”

The Covid-19 pandemic severely disrupted information channels. Supply was limited due to movement restrictions, leading to mounting inflationary pressures. In response to the pandemic-induced economic slowdown, fiscal policies globally focused on stimulating demand, it said.

India also witnessed cost-push pressures due to bottlenecks in the supply chain and logistics. Increases in energy prices, metal prices and costs of logistics added to the input cost pressures of firms. The inflationary situation was further exacerbated in 2022 by Russia’s invasion of Ukraine, which increased oil and commodity prices, the NCAER paper said.