Marco Bottone, Cristina Conflitti, Marianna Riggi, Alex Tagliabracci June 30, 2021
The shock of Covid-19 is unprecedented in terms of its origin and impact. Seen from a macroeconomic perspective, the spread of the epidemic and the measures adopted to counter it have led to an unusual and simultaneous sharp drop in supply and demand. Researchers have debated at length the impact of this shock on corporate pricing behavior, which is difficult to predict due to its exceptional features but is of the utmost importance as Covid-19 hit the economies of United States and the euro area against the background of a still low inflation environment. .
The debate has mainly focused on the prevalence of demand versus supply channels, or on the links between them (Baqaee and Farhi 2020, Bekaert et al. 2020, Brinca et al. 2020, del Rio-Chanona et al. 2020). A Keynesian theory of supply shocks has emerged (Guerrieri et al., 2020) where temporary supply shortages that asymmetrically affect different sectors of the economy trigger an even greater contraction in aggregate demand than the initial shocks. themselves, leading to deflationary pressures.
Empirical evidence to directly assess how firms have perceived this type of shock and its impact on their expectations and pricing policies is scarce, reflecting the lack of data on firm behavior and expectations. Two exceptions are Balleer et al. (2020) on survey data at German enterprise level and Balduzzi et al. (2020) on Italian companies.
In our recent work (Bottone et al., 2021), we provide a complete characterization of the impact of the Covid-19 shock on the pricing behavior of firms using a unique data set, the quarterly survey of the Bank of Italy on inflation and growth expectations (EMIS),1 which includes ad hoc questions since the wave carried out in March 2020, shortly after the outbreak of the epidemic in Italy.
Covid-19 survey design and special questions
Beyond assessments and expectations relating to the general economic situation and specific conditions of companies, the EMIS includes quantitative questions on the inflation expectations of companies’ consumers at different time horizons and on the expected evolution of product prices. businesses over the next 12 months. Companies are also asked to quantify the role of several factors influencing their pricing strategies, including the attention paid to the pricing policies of their competitors. Our analysis uses the four waves carried out in 2020, during the different phases of the pandemic in Italy. In March, June and September 2020, companies were also asked about the channels through which the epidemic affected their business. A clear result emerges (see Figure 2): from the start of the epidemic, the majority of companies perceived it as a demand shock and this perception has remained robust over time, as also shown by the June surveys. and September.2 For around 50% of companies, Covid-19 has had an impact on their activity mainly through the domestic demand channel. Foreign demand has also played an important role, particularly in the early stages of the pandemic, as the share of companies perceiving Covid-19 as a supply or financial shock represents only around 20% of the population.
Figure 1 Main transmission channels of Covid-19
Source: EMIS data.
Remarks: Each bar represents the share of respondents for each option. Each participant could only choose one option, so the sum of the bars for each quarter is 100. This question was not included in the December 2020 wave.
Starting with the June 2020 wave, companies were asked how many months they think it will take to return to their pre-epidemic activity levels, providing a measure of the expected persistence of the Covid shock. on their activity. Figure 2 shows that the vast majority of companies perceived Covid-19 as having a lasting impact on their business and that the average time needed to recover grew somewhat over time. A small percentage of companies believed that the Covid shock would have permanent effects on their business.
Figure 2 Perceived persistence of shock
Source: EMIS data.
Remarks: The left panel shows the distribution of responses to the qualitative question on the time required to return to normality. The right panel shows the kernel distributions for the exact number of months reported by companies responding “few months needed”.
We estimate several specifications to identify the drivers of corporate pricing policies and inflation expectations during the pandemic. Our main results can be summarized as follows. Perceiving Covid-19 as a demand or supply shock has no significant impact on companies’ pricing strategies or on their inflation expectations. Rather, the main drivers of the price changes expected by companies are the perceived persistence of the impact of Covid-19 on companies’ business activity and the strength of competitive pressures. The longer it is deemed necessary to return to normal activity levels and the greater the attention paid to the pricing policies of their competitors, the more likely companies are to reduce the prices of their products. On the contrary, companies’ inflation expectations vary negatively with the expected persistence of the effects of Covid-19 on the general economic situation.
The long history of EMIS also allows us to compare the response to the Covid-19 shock with those of previous recession episodes. First, we examine the role of liquidity and financial constraints, which have been identified by the literature as relevant drivers of corporate pricing policies during the Great Recession and the sovereign debt crisis. Our results suggest that in this respect, the pandemic crisis is very different from the previous ones. Most companies continued to report an appropriate liquidity situation during the 2020 survey waves (see also De Socio et al. 2020) and, more importantly, it was found that liquidity and financial conditions n had not influenced pricing decisions during the pandemic. This may reflect the exceptional fiscal and monetary responses, which have prevented the pandemic crisis from turning into a financial crisis.
Second, again differently from what happened in the aftermath of the Lehman collapse and sovereign debt crisis, revisions to one-year inflation expectations relative to the cycle before the pandemic shock are quantitatively attenuated and concentrated around zero, with half of firms revising upward and half downward (Figure 3). Arguably, the complexity of this shock meant that companies were highly uncertain of its inflationary implications – as were markets, analysts and academics – resulting in only a marginal revision of their inflation expectations.
figure 3 Business inflation expectations and their revision
Source: Authors’ calculations on SIGE data.
To note: The left column plots the 12-month distribution of inflation expectations while the right column their evolution compared to the previous round. The red vertical line represents the value of the inflation treatment (i.e. the last realized figure available for Italian inflation) in the corresponding quarter while the dotted blue line represents the change in the treatment of information between two consecutive laps.
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 d ‘Economy.
Balleer, A, S Link, M Menkhoff and P Zorn (2020), “Demand versus supply: Price Adjustment during the Covid-19 pandemic,” VoxEU.org, July 27.
Baqaee, D and E Farhi (2020), “Supply vs. Demand: Unemployment and Inflation in the Covid-19 Recession,” VoxEU.org, June 29.
Bekaert, G, E Engstrom and A Ermolov (2020), “Aggregating Demand and Aggregated Supply Effects of COVID-19: A Real-Time Analysis”, Finance and Economy 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, JB Duarte and M Faria e Castro (2020), “Decomposition of demand and supply shocks during COVID-19,” VoxEU.org, June 17.
del Rio-Chanona, RM, P Mealy, A Pichler, F Lafond and D Farmer (2020), “Demand and supply shocks in the COVID-19 pandemic: an industry and industry perspective occupation ”, Documents 2004.06759, arXiv.org.
From Socio, A, S Narizzano, T Orlando, F Parlapiano, G Rodano, E Sette and G Viggiano (2020), “The effects of the COVID-19 shock on liquidity needs, balance sheets and company risks,” notes Covid, Bank of Italy.
Guerrieri, V, G Lorenzoni, L Straub and I Werning (2020), “Viral Recessions: Lack of Demand During Coronavirus Crisis,” VoxEU.org, May 6.
1 The survey is aimed at companies in industry, private non-financial services and construction with 50 or more employees. The sample consists of approximately 1,500 companies.
2 This evidence could be partly affected by the composition of our sample, which does not take into account small service companies such as bars, restaurants and small hotels, made up of companies with at least 50 employees, which would have could potentially indicate “the offer” as the main transmission mechanism. Still, the percentage of businesses that choose “demand” is similar among those that might stay open and those forced to be shut down by government restrictions. In addition, the size of the company and the geographical area do not play a crucial role, while the exposure to foreign demand slightly increases the likelihood of choosing the demand channel.