Marco Bottone, Cristina Conflitti, Marianna Riggi, Alex Tagliabracci June 30, 2021
The Covid-19 shock is unprecedented in its origin and effects. From a macroeconomic perspective, the spread of the epidemic and the measures taken to combat it have led to an unusual and, at the same time, sharp decline in supply and demand. Scientists have discussed at length the impact of this shock on corporate pricing behavior, which is difficult to predict due to its extraordinary characteristics, but is of paramount importance as Covid-19 has hit the US and euro area economies in the context of a persistently low inflationary environment.
The debate mainly focused on the prevalence of the demand and supply channels or the links between them (Baqaee and Farhi 2020, Bekaert et al. 2020, Brinca et al. 2020, del Rio-Chanona et al. 2020). A theory of Keynesian supply shocks has emerged (Guerrieri et al., 2020), in which temporary supply shortages that have an asymmetrical effect on different economic sectors trigger a decline in aggregate demand that is even stronger than the original shocks themselves, leading to deflationary pressures.
Empirical evidence to directly measure how companies perceived this type of shock and its impact on their expectations and pricing policies is poor due to the lack of data on company behavior and expectations. Two exceptions are Balleer et al. (2020) on survey data at the German company level and Balduzzi et al. (2020) about Italian companies.
In our most recent work (Bottone et al., 2021) we offer a full characterization of the impact of the Covid-19 shock on corporate pricing behavior using a unique set of data, the Bank of Italy’s quarterly Survey on Inflation and Growth Expectations (SIGE. ). ),1 which has included ad hoc questions since the wave in March 2020, shortly after the epidemic broke out in Italy.
Survey design and Covid-19 special questions
In addition to assessments and expectations regarding the general economic situation and the specific conditions of the companies, SIGE includes quantitative questions on the consumer inflation expectations of the companies over different time horizons and on the planned change in the companies’ product prices over the next 12 months. Companies are also asked to quantify the role of various factors in influencing their pricing strategies, including the attention paid to their competitors’ pricing policies. Our analysis uses the four waves carried out in 2020 during different stages of the pandemic in Italy. In March, June and September 2020, companies were also asked about the channels through which the epidemic affected their operations. A clear result is emerging (see Figure 2) – the majority of companies perceived the epidemic as a demand shock from the start and this perception has remained robust over time, as the surveys from June and September show.2 For around 50% of companies, Covid-19 impacted their business primarily through the domestic demand channel. Foreign demand also played an important role, especially in the early stages of the pandemic, while the proportion of companies that perceive Covid-19 as a supply or financial shock only makes up around 20% of the population.
illustration 1 Main transmission channels for Covid-19
source: SIGE data.
Remarks: Each bar represents the proportion of respondents for each option. Each participant could only choose one option, so the sum of the bars in each quarter is 100. This question was not considered in the December 2020 wave.
Starting with the June 2020 wave, companies were asked how many months they thought it would take them to return to their pre-epidemic business levels, which provides 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 a long-lasting impact on their business and that the average recovery time increased somewhat over time. A small percentage of companies believed that the Covid shock would have lasting effects on their business operations.
Figure 2 Perceived persistence of shock shock
source: SIGE data.
Remarks: Left panel shows the distribution of the answers to the qualitative question about the time it takes to return to normal. The right field shows the kernel distributions of the exact number of months given by companies that respond “needs a few months”.
We estimate several specifications to identify the drivers of corporate pricing and inflation expectations during the pandemic. Our main findings can be summarized as follows. The perception of Covid-19 as a demand or supply shock has no material impact on companies’ pricing strategies or their inflation expectations. Instead, the main drivers of the companies ‘planned price changes are the perceived persistence of the effects of Covid-19 on companies’ business operations and the strength of competitive pressures. The longer the time that is deemed necessary to return to normal business levels and the more attention is paid to the pricing policies of their competitors, the more likely firms are to lower their product prices. Corporate inflation expectations, on the other hand, vary negatively with the expected persistence of the effects of Covid-19 on the general economic situation.
SIGE’s long history also allows us to compare the response to the Covid-19 shock with that of previous recession episodes. First, we examine the role of liquidity and financial constraints identified in the literature as relevant drivers of corporate pricing policy during the Great Recession and the sovereign debt crisis. Our results suggest that the pandemic crisis is very different from previous ones in this regard. Most companies continued to report adequate liquidity levels during the 2020 survey waves (see also De Socio et al. 2020) and, more importantly, that liquidity and financial conditions did not affect pricing decisions during the pandemic. This could reflect the extraordinary fiscal and monetary responses that prevented the pandemic crisis from turning into a financial crisis.
Second, unlike after the Lehman collapse and the sovereign debt crisis, the revisions of inflation expectations for one year in relation to the round preceding the pandemic shock are quantitatively subdued and are concentrated by half of the companies revising up and half down (Figure 3). The complexity of this shock arguably meant that corporations – as well as markets, analysts and academics – were very uncertain about the inflationary effects and revised their inflation expectations only slightly.
Figure 3 Inflation expectations of companies and their revision
source: Calculations by the authors on SIGE data.
Note: The left column shows the distribution of inflation expectations for the next 12 months, while the right column shows their variation compared to the previous round. The red vertical line represents the inflation treatment value (i.e. the last available realized figure for Italian inflation) in the corresponding quarter, while the blue dashed line represents the variation in information treatment between two consecutive rounds.
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 of Economics.
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 versus Demand: Unemployment and Inflation in the Covid-19 Recession,” VoxEU.org, June 29.
Bekaert, G, E Engstrom and A Ermolov (2020), “Aggregate Demand and Aggregate Supply Effects of COVID-19: A Real-time Analysis”, Finance and Economics Discussion Series 2020-049, Board of Governors of the Federal Reserve System.
Bottone, M., C. Conflitti, M. Riggi and A. Tagliabracci (2021), “Inflation Expectations and Price Strategies of Companies 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), “Decomposing 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), “Supply and demand shocks in the COVID-19 pandemic: An industrial and professional perspective”, Papers 2004.06759, arXiv. org.
De Socio, A, S. Narizzano, T. Orlando, F. Parlapiano, G. Rodano, E. Sette, and G. Viggiano (2020), “The Impact of the COVID-19 Shock on Liquidity Needs, Balance Sheets, and Risk of companies, ”notes Covid, Bank of Italy.
Guerrieri, V., G. Lorenzoni, L. Straub and I. Werning (2020), “Viral Recessions: Lack of Demand during the Coronavirus Crisis”, VoxEU.org, May 6th.
1 The survey is aimed at industrial, non-financial private services and construction companies with 50 or more employees. The sample consists of around 1,500 companies.
2 This evidence could be partially influenced by the composition of our sample, which ignores small service businesses such as bars, restaurants, and small hotels, which are made up of businesses with 50 or more employees who could potentially have given “utilities” as the main transmission mechanism. However, the percentage of businesses that choose “demand” is similar between those that could stay open and those that government restrictions require. Also, the size and geographic area of the business are not a critical factor during the risk of foreign demand increases the likelihood of choosing the demand channel.