The Transmission of International Monetary Policy Shocks on Firms' Expectations

Abstract

Motivated by the dominant role of the US dollar, we explore how monetary policy (MP) shocks in the US can affect a small open economy through the expectation channel. We combine data from a panel survey of firms' expectations in Uruguay with granular information about firms' debt position and total imports on a monthly basis. We show that a contractionary MP shock in the US reduces firms' inflation and cost expectations in Uruguay. This result contrasts with the inflationary effect of this shock on the Uruguayan economy, suggesting uncertainty about the policy regime. We discuss the issues and challenges of this expectation channel.

Belief-dependent pricing decisions

“…In that line, when inflation sharply increased in March 2020, that group of firms also increased substantially. There is also a clear pattern of seasonality as a significant proportion of price adjustments are concentrated during January and July, consistent with findings for other countries (see for example Nakamura and Steinsson (2008)), and related to wage indexation and utility price adjustments as documented by Frache and Lluberas (2019). As shown in 3.4b, pricing-adjustment decisions are also heterogeneous across firm sizes as large firms are the ones that are changing prices more frequently.…”

“…When inflation starts returning to the historical average of 8%, forecast errors converge to less than 2 percentage points. Although average expectations exhibit some persistence, using the same sample for a more extended period, Frache and Lluberas (2019) show that firms in Uruguay are much better predictors of inflation than surveyed firms in countries with lower inflation such as New Zealand, Kumar et al (2015). We also look at accuracy in predicting inflation by firm size.…”

“…While there is a growing literature on how expectations are formed, Coibion and Gorodnichenko (2012), Andrade and Bihan (2013), Frache and Lluberas (2019), and Giacomini et al (2020), there is much less evidence on how expectations correlate with economic decisions. This is partly because most of the literature studying expectations relies on forecasts from professionals.…”

The Causal Effects of Expected Depreciations

“…First, the cross-sectional distribution of perceptions and expectations of the exchange rate is substantially more compressed than the analogous objects for the inflation rate. This fact confirms the intuition that the nominal exchange rate of the local currency against the US dollar is a nominal variable that receives substantial attention by firms in developing and emerging market economies (see also Frache et al (2023)). Second, there is substantially more disagreement about the expected future level of the exchange rate compared to the current level of the exchange rate.…”

“…Most of the evidence in the literature comes from developed economies, but there is some evidence from developing countries. Frache et al (2023) show that firms in Uruguay form inflation expectations, paying particular attention to the price of the USD, and that international shocks affect their inflation expectations and decisions. D'Acunto and show that consumers across countries use specific salient prices to form expectations.…”