Dec. 21, 2022

Inflation, Monetary Policy, and the Real Economy

John Graham, Brent Meyer and Sonya Ravindranath Waddell

As we head into 2023, we face an economy with elevated levels of inflation, upward pressure on wages that emanates both from the tight labor market and the continued need for cost-of-living adjustments, supply chain frictions that have not entirely abated, and monetary policy that is working to bring price growth back into normal territory. The question firms and households are asking is: What will the economy look like in 2023, and how does that outlook impact decisions being made today? In the most recent CFO Survey, we ask financial leaders across the country how monetary policy might affect their spending plans and to what extent they are factoring inflation into wage increases for next year. We find that although monetary policy has grown as a key concern for respondents, most note that current interest rate levels have not affected their capital or non-capital spending plans. We also find evidence that if employers were looking to raise wages to account for inflation in 2022, the catch-up was only partial. The most recent wage increases remain below the increase in the cost-of-living many workers faced in 2022.

What Will Happen to Corporate Bottom Lines?

The Q4 CFO Survey results did not indicate a dramatic change in the way that financial leaders view the U.S. economy and its trajectory. However, there was some deterioration in firms' views of their own prospects in the coming year. The index measuring average optimism about own-firm economic prospects fell slightly from the third to the fourth quarter (68.0 to 67.2) alongside expectations for revenue growth in 2023 that slowed from 7.4 percent reported in last quarter's survey to 4.7 percent reported in this quarter.

There has been a material deterioration in CFOs' outlook for the U.S. economy and output growth over the past year. Moreover, relative to previous quarters, reported concerns over the health of the economy and own-firm demand are mounting; no doubt, the lower revenue projections are connected to these broader economic concerns.

The Interest Rate Sensitivity of Spending

The Federal Open Market Committee's (FOMC) work to tame inflation through a steady increase in the target fed funds rate has been weighing on the minds of business executives. For CFO Survey respondents, concerns over the stance of monetary policy rose notably in the fourth quarter. One interpretation of this concern is that respondents worry that increased rates will slow consumer spending and thus slow demand for their goods and services. Another possible interpretation might be that they anticipate increased interest rates will dampen their own spending. However, in Q4 most respondents report that the current level of interest rates is not impacting either capital or non-capital spending plans.

Two-thirds of our panel reported that the current level of interest rates was not causing them to pull back on spending plans. When we asked why the current level of rates was not impacting capital investment, many of those firms indicated they are not financing investment plans through borrowing or that their plans are not interest rate sensitive. Some firms reported that they would slow spending if the fed funds rate rose above the target range of 3.75-4.00 percent that prevailed while the survey was in the field. On average, the fed funds rate that would cause these firms to pull back on capital spending was 6.4 percent (median: 6 percent), while the level that would cause firms to pull back on non-capital spending was 6.8 percent (median: 6 percent).

At first blush, this may suggest a muted transmission of interest rate moves onto business spending plans (although it is possible that a higher path of rates will eventually deter capital and non-capital spending once current projects are completed.)

What is clear is that these results are generally consistent with other surveys asking firms the extent to which rate increases are weighing on spending. In the Atlanta Fed Business Inflation Expectations (BIE) survey, for example, business executives in that panel were asked how current interest rates were impacting capital investment decisions. Roughly 30 percent of firms indicated the current level of rates was having a major or severe impact on capital investment plans, a very similar fraction of firms that were pulling back on capex in The CFO Survey.

Moreover, in the BIE, firms were asked to respond to a hypothetical question about the impact of a 1, 2, or 4 percentage-point increase in interest rates by the end of 2023 on capital spending plans in 2024. The most significant impact of future rate increases in 2023 on 2024 capex didn't kick in until after the 2 percentage-point hypothetical path. This is consistent with the firms in our panel that indicated they'd pull back on capital and non-capital spending plans should interest rates rise by more than 2 percentage points from their prevailing levels in late November.

Is Compensation Keeping up with Inflation?

The past two years have seen the highest inflation in the U.S. economy since the early 1980s; thus, we have been keenly interested in understanding how firms (and workers) are coping. In the Q4 CFO Survey, we asked financial executives about the extent to which they are factoring higher than normal inflation into their most recent compensation increases. Our questions do not include the extent to which firms have engaged in one-off wage adjustments over the past year or have increased the value of amenities at work (e.g., offering increased remote work or heavily subsidizing workers for expenses such as community costs or cafeteria purchases). That said, our results suggest that firms' most recent compensation increases are well above what they typically offer. However, in many circumstances, they remain below growth in observed price statistics (e.g., the Consumer Price Index) over the last year, suggesting either a continued decline in real wages or at least a less-than-full catch-up to the inflation of the past two years.

Digging into the results, about 80 percent of respondents (and over 90 percent of large firms) provide annual increases in compensation and of those, about 70 percent report adjusting annual compensation changes to reflect the rate of inflation. In other words, of our sample, not quite 60 percent provide an explicit annual cost of living increase to their employees. However, when asked to disaggregate the inflation-related and the merit-related sides of the compensation change, firms report that for the most part, cost-of-living adjustments did not keep up with inflation realized in the last year. The cost-of-living adjustment alone averaged 3.3 percent for next year. In fact, total compensation growth (inflation plus merit) averaged 6.4 percent — higher than what was reported as "normal" (4.8 percent) but about 2 percentage points lower than the expected growth in the Consumer Price Index (CPI) in 2022. Perhaps reflecting the tight labor market, even those firms that do not include a cost-of-living adjustment in annual compensation changes had a higher average merit increase than normal (4.3 percent versus 3.5 percent).

On average, what percent annual increase in total compensation did (or will) your firm provide employees for the most recent compensation round?
Mean (and Median) Percent Increases, by Type of IncreaseMerit Only
Inflation Adjustment
Total (Merit + Inflation Adjustment)
Note: Data reflect responses from firms that indicated they provide annual increases in compensation (base of variable) to employees. For comparison, firms were also asked what percent annual increase in compensation would be considered normal, or line with the firm's recent averages. Merit Only reflects responses from firms that do not incorporate inflation adjustments. Merit, Inflation Adjustment, and Total reflect responses from firms that incorporate inflation adjustments. Responses are unweighted and winsorized at 2.5% and 97.5% to remove the potential influence of extreme values.
Source: Duke University, FRB Richmond and FRB Atlanta, The CFO Survey - Q4 2022 (November 14 - December 2, 2022)


Financial executives face substantial headwinds going into 2023 and conditions remain highly uncertain. We have yet to fully realize the impact of rising interest rates on firm spending or consumer demand, and expectations for U.S. economic growth deteriorated in the last year. More recently, CFO Survey respondents reported declining optimism about their own companies' prospects and revenue growth in 2023. Many, if not most, workers will not see wage increases make up for the recent inflation. Nonetheless, The CFO Survey respondents' nominal revenue growth projections remain positive and thus far higher interest rates have not impacted spending or employment plans for the majority of respondent firms.

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