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• Predicting PCE Using the Richmond Fed Price Measure
• Measuring Inflation

Transcript

Tim Sablik: My guests today are Pierre Sarte and Sonya Waddell. Pierre is a senior advisor and Sonya is a vice president and economist, both at the Richmond Fed. Pierre and Sonya, welcome back to the show.

Pierre Sarte: Thank you, Tim.

Sonya Waddell: Thanks for having us, Tim.

Sablik: Keeping track of inflation — where price levels stand today, which direction prices are going, and what components are driving them in that direction — is a critical task for monetary policymakers. There are lots of ways to do that, some of which we discussed with John O'Trakoun in a recent episode.

Today, we'll discuss another potential source of intel on inflation: the Richmond Fed's regional surveys of business activity. These surveys have been sent to manufacturing and non-manufacturing firms throughout the Fifth District since 1993 and have included questions about current and expected price and cost changes since 2011.

Let's start at the beginning. Why did the Richmond Fed start asking businesses about the price changes they see?

Sarte: More generally, as the regional bank for the Fifth District, it behooves us to keep track of economic conditions in our region. This contributes to the national picture at FOMC meetings in a way that all other regional banks are also required to do.

As you mentioned, Tim, keeping track of inflation is a critical task for monetary policymakers. But the process of getting a read on inflation at the national level takes time. The process of surveying prices on a national scale at a granular level is very labor intensive.

In contrast, asking businesses in our region about the prices they see gives us more real-time information and, potentially, a peek into where inflation is heading. The trade-off, of course, is that regional surveys are not necessarily as comprehensive as those carried out by the Bureau of Economic Analysis, and we need to account for correspondingly larger sampling errors.

Sablik: OK, given those trade-offs, Sonya, what kind of questions have we asked survey respondents about prices?

Waddell: Let me back up a little bit. The questions that feed this analysis are a little different from most of the questions on our business surveys. Most of the questions that we ask are what we call "categorical questions," which are questions with a limited number of responses. For example, we ask if employment is higher, lower, or the same as last month. We give them just these three choices.

The questions that feed our price analysis ask firms for an actual percentage change. We ask them how the prices they charge to customers compare with this time last year in percentage terms. Unfortunately, we can't ask for price changes on every product or service our respondents offer because that would be much too time-consuming for any participant. Still, asking overall percentage change in prices charged gives us a sense of what firms are implementing and planning with respect to price growth.

Sablik: How does this information compare to what other Reserve Banks gather from their regional surveys?

Waddell: Tim, the Richmond Fed is somewhat unique among Reserve Banks with our price and cost questions. A lot of Reserve Banks run monthly surveys of firms, but most of them stick to the kinds of categorical questions that I discussed earlier, even for prices. Some Reserve Banks and business surveys collect less frequent or slightly different data about percentage change in prices.

For example, in the CFO Survey that we run with the Federal Reserve Bank of Atlanta and Duke's Fuqua School — I think that was on a prior podcast as well — we do ask about percentage change in prices. But we ask about the calendar year and we ask at a quarterly frequency.

As another example, the [Federal] Reserve Bank of Philadelphia asks quarterly questions about expected percentage change in prices but monthly asks if prices were up, down, or the same from the prior period. The Richmond Fed is unique among Reserve Banks in asking monthly questions about a 12-month percentage change in both prices charged to customers and prices paid for inputs.

Sablik: One commonly cited gauge of inflation is the personal consumption expenditures price index, or PCE price index, which comes from the Bureau of Economic Analysis. What does the PCE index tell us compared to the price change data gathered from the Richmond Fed's regional surveys?

Sarte: The PCE price index focuses on prices paid by consumers for final goods — for example, a restaurant meal, clothing, or a personal computer. The Richmond Fed asks about prices paid by consumers for final goods but also [by] businesses. Firms typically purchase intermediate inputs for their own production — for example, steel — which can then affect prices consumers pay downstream for goods like cars. So, in spite of being a regional survey, we try to survey the entire landscape of prices.

Sablik: Is there a strong correlation between these two sets of data? Or, put another way, how well do they move together over time?

Sarte: One would, of course, expect to see some positive correlation between price changes reported in our regional surveys and official measures of inflation. It would be problematic if they weren't. The more relevant question, though, is whether price changes reported in our survey offer helpful information about the behavior of PCE inflation that cannot be already surmised from recent or past PCE data.

The answer to that question is a qualified yes. In normal times when inflation bounces around without too much variation, so do the reported price changes in the Richmond Fed survey, but not in a way that offers obvious hints about the behavior of PCE inflation beyond what past PCE data itself suggests. However, in times where PCE inflation is changing more dramatically, reported price changes in the Richmond Fed survey are indicative of where PCE is heading almost a month before the actual release of PCE data. The reason is that during those times, reported price changes in our surveys are pronounced enough that we are able to get a glimpse of where overall inflation is heading, even accounting for the larger sampling error.

Waddell: As Pierre indicated, since 2021, there has been a particularly strong relationship between the Richmond Fed price measure and PCE inflation. As the production costs facing manufacturers rose in 2020 — with supply chain constraints, input shortages, labor shortages, etc. — they started to increase prices to other businesses and to households. Those price increases then started to show up among service providers. Not surprisingly, this showed up in consumer price inflation as measured by the PCE. The firms in our survey were a piece of the whole inflation picture.

Sablik: Given this relationship, it seems like the price changes reported in the Richmond Fed's surveys could be used in inflation forecasting models. You wrote about this potential application in a recent Economic Brief. Can you walk us through how that might work?

Sarte: It isn't so much about forecasting as it is about "nowcasting." As I have mentioned, one of the strengths of our regional survey is that it gives us a sense of what is happening to prices almost in real time. Actual PCE inflation is released by the Bureau of Economic Analysis with almost a two-month lag. So, for example, March PCE data would be released at the end of April.

You could try to infer the March PCE inflation level based on the recent behavior of PCE inflation. However, having the reported price changes for March in our regional survey in real time turns out to be informative about that PCE release a month later in a way that is statistically significant. This is especially true, as I have noted, in times when PCE inflation is moving around a lot.

Sablik: How might this application of Richmond Fed survey data be used by monetary policymakers? When might it come in handy?

Sarte: Given recent events, it's during a government shutdown in which the Bureau of Economic Analysis cannot carry out its surveys. As we have talked about, the combination of recent PCE inflation data and current regional survey readings give us a pretty good glimpse into current PCE inflation. So, during a shutdown, when information is necessarily missing, having the regional surveys to help us complement whatever other information is available gives us a best guess, of sorts, for the missing information.

Even in normal times, the real-time aspect of the regional surveys gives us a sense of what the actual PCE index might turn out to be almost a month early, even accounting for their larger sampling error. As a general principle, when assessing the state of things, one would always choose to make more informed, rather than less informed, decisions if at all possible.

There is one other aspect of the regional surveys that we really haven't talked about so far. Our surveys allow us to see some nuances in what our survey respondents are responding through written comments. These nuances give us a narrative for the numbers we are seeing, helping us build more of a complete picture of the state of the economy and where that state might be heading, in a way that numbers alone cannot convey. That also is an important way of having more information rather than less.

Sablik: Are there any other applications of the regional survey data that the Richmond Fed is looking at?

Waddell: As our survey director, Jason Kosakow, and his team does the hard work of recruiting and retaining survey participants, we are continuing to find new and different ways to use the regional survey data — both the numbers and the comments. For example, we ask less frequent questions about important topics, such as inflation expectations and AI adoption, and we use our categorical questions for insight into employment dynamics or trends in shipments, revenues, and demand in the region and in the broader U.S. economy.

Tim, let me also take a minute on this podcast to thank our survey respondents for providing us with such useful information every month. I've now worked with two presidents of the Richmond Fed, both of whom have found the information from our surveys a critical input into their monetary policy deliberations and, thus, makes its way to the FOMC table. With the help of economists like Pierre, we're still finding new ways to make use of the information on business conditions that our respondents so graciously provide to us.

So, thank you, if you're listening.

Sablik: Yes, thank you. And thank you, Pierre and Sonya, for coming on to talk about the use of these surveys and telling us about a potential new way of tracking inflation.