Sept. 28, 2022

Learning About Inflation and Cost Pressure From Financial Leaders

Zach Edwards, Brent Meyer and Sonya Ravindranath Waddell

Over the past few months, the U.S. has seen some of the highest inflation in four decades. The overall Consumer Price Index (CPI) rose 8.3 percent over the past 12 months through August 2022. Price increases both contribute to and emanate from the choices that households and businesses make about both what they pay for and what they charge for goods and services. In the third quarter 2022 CFO Survey, we find that more firms reported elevated cost increases, although expectations for the duration of the higher-than-normal cost pressures ebbed since 2021. Firms indicated that they are able to pass a larger chunk of those cost increases on via price increases than they were when we last asked this question in the fourth quarter of 2021. Not surprisingly, some differences emerged when looking across industries.

The Problem of Larger Than Normal Cost Growth

Larger than normal cost increases persisted for firms nationwide for more than a year. This quarter, more than half of firms reported abnormally large increases in the majority of their costs, with fewer than 5 percent reporting no abnormally large cost increases. What is more, these percentages have changed dramatically since the second and fourth quarters of 2021.

The breadth of cost increases differs across industries: Most notably, goods producers more frequently reported increases in the majority of their costs than service providers. Anecdotally, goods producers report particularly large increases in freight and input costs, while service providers are more likely to report larger than normal increases in the cost of labor.

How Long Will Cost Increases Last?

Uncertainty about the duration of cost increases continued to weigh on survey respondents. It is clear from the chart below that there was little consensus about how long the cost increases will last, and almost 15 percent of respondents noted that they were simply "uncertain" about how long the increases will continue. What is clear, though, is that costs were not yet on the decline for the vast majority of respondents.

On the positive side, firms' expectations of the duration of cost increases have moderated in the last year. In the third quarter of 2022, the expectation for the duration of cost increases was 9.2 months, compared to 10.5 months in the fourth quarter of 2021 (and 8.6 months in the second quarter of 2021).1

To be clear, the larger than normal costs that firms are experiencing have persisted much longer than originally anticipated. On average, firms in the fourth quarter of 2021 expected cost increases to return to normal in roughly 11 months, putting us around present day. With this survey, cost increases seem likely to abate by the middle of 2023. Although cost increases have lasted much longer than firms originally anticipated, the downward revision in expected duration of cost pressures in the third quarter of 2022 signals that firms may see a light at the end of the tunnel. While there is reason to feel optimistic given this downward revision, breaking the data down by sector reveals a slightly different story.

Service providers were far more likely than goods producers to expect abnormally large cost increases to last more than 12 months. Perhaps this is connected to the difference between inputs, freight cost, and labor cost: Against a backdrop of improving supplier delivery times (as noted by the ISM's PMI indices), it is possible that firms expect input and freight cost increases to abate but expect issues regarding labor availability to persist.

Hiring Remains Difficult

According to CFO Survey respondents, it has not gotten any easier to find workers since the beginning of the year; in fact, many reported that it got harder, especially finding higher-skilled workers. (On the other hand, the Atlanta Fed wage tracker indicates that wage increases are still sharpest among the low-to-mid skilled workers.) The continued difficulty finding workers could explain a reticence among many respondents to expect their cost increases to abate within the next 12 months.

What About Margins?

On one hand, firms can limit the impact of cost increases on their margins by passing them through to the prices that they charge customers. On the other hand, the more cost increases are passed through, the stronger the impact on the overall level of prices that consumers face. The CFO Survey data indicate that over time, firms have been able to gradually pass on a larger share of cost increases to the prices they charge customers.

Since the second quarter of 2021, the share of firms able to pass on any portion of cost increases has grown 5 percentage points to almost 80 percent, and the share of firms able to pass on more than 50 percent of their cost increases rose by more than 5 percentage points to 41 percent. No doubt at least some of that pass-through is hitting consumers, as evidenced by the highest CPI inflation rates seen since the early 1980s. As such, relief may come in the form of a reduction in cost increases or a reduction in demand.

Despite the growing ability of firms, generally, to pass cost increases on, the difference between goods producers and service providers is notable. Using a similar weighting scheme as before,2 we find that the average goods producer is able to pass on about 66 percent of cost increases, compared to only 47 percent for service providers.

Conclusion

The data collected as part of the third quarter CFO survey suggest that firms' expectations have improved regarding the duration of unusually high cost increases. Furthermore, many firms have been increasingly able to insulate themselves from upward cost pressures by passing them along to customers. However, both the expected duration of cost increases and the ability to pass them through to customers differ notably between service-sector firms and goods producers. While this report suggests that lower levels of inflation are unlikely in the near future, one silver lining is that firms across the board revised their expectations for price and unit cost growth through 2022 down from last quarter. Perhaps there is light at the end of the tunnel.

 
1

Expected duration of cost increases was calculated by summing each product of the percentage of responses for each option and the maximum duration of that bin. Fifteen months was used as the weight for the ">12 months" bin. For example, in 2022 Q3 we calculate: .031*3 + .182*6 + .140*9 + .178*12 + .305*15 = 9.16.

2

Expected value of pass-through is calculated by summing each product of the percentage of responses for each option and the maximum pass-through of that bin. For example, for goods producers we calculate: .106*0 + .121*25 + .136*50 + .242*75 + .379*100 = 65.875.

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