Business inflation expectations jumped sharply during the pandemic-era price surge, with small firms seeing expectations climb to nearly 7% by 2022 before falling back as inflation cooled, according to a new Federal Reserve Bank of San Francisco report published this month. The analysis, which examined quarterly survey data from U.S. manufacturers and service businesses between 2018 and 2025, found that firms' inflation expectations diverged dramatically from professional forecasters during the inflation surge and moved closer to volatile household expectations. By the end of 2025, however, business expectations had largely returned to their pre-pandemic characteristics following the Federal Reserve's policy response and the subsequent decline in inflation.
Between 2019 and early 2020, firms' one-year-ahead inflation expectations closely tracked professional forecasters' expectations. Starting in early 2021, as inflation rose above 2%, business expectations abruptly disconnected from professional forecasters and increased sharply to nearly 7% by 2022, similar to household expectations during the same period. Small firms with 1 to 19 employees saw expectations increase faster and more strongly than larger firms with 20 or more employees, with the difference reaching roughly 2 percentage points at the peak in 2022. In 2021, a 1 percentage point increase in perceived inflation was associated with 1 percentage point higher one-year-ahead inflation expectations for small firms but with only 0.2 percentage point higher expectations for larger firms. Firms' longer-term inflation expectations, measured as the expected average inflation rate between one year and five years out, rose from slightly above 2% in late 2019 to 4.8% in late 2022, then gradually fell to 3.3% in late 2025.
The report finds three main patterns drove the shift in business expectations during the inflation surge: firms became more sensitive to current inflation perceptions, their longer-term expectations temporarily drifted up, and their perceptions of the Federal Reserve's inflation goal increased. The authors write that "the behavior of firms' inflation expectations during the pandemic-era inflation surge indicates that they can deviate substantially from professionals' expectations and move closer to those of households, especially when inflation rises sharply." The analysis reveals that small firms' inflation expectations behaved more similarly to household expectations, while medium to large firms' expectations remained somewhat closer to those of professional forecasters throughout the period.
The report identifies two key mechanisms behind the temporary rise in business expectations. First, inflation expectations can be shaped by firm-specific perceptions of inflation when companies don't have access to complete information about overall inflation, particularly during periods of economic volatility. Small firms, which may have fewer resources to track economy-wide data, became especially sensitive to the specific prices they observed in their own operations. Second, firms' beliefs about the central bank's inflation goal matter for their longer-term expectations. During the pre-pandemic period through 2021, the perceived inflation goal was relatively stable, but following the sharp increase in inflation, both longer-term expectations and the perceived inflation goal increased in 2022 and 2023. After 2023, following the policy rate hiking cycle and lower inflation rates, firms' perceived inflation goal fell, potentially explaining the decline in longer-term expectations toward pre-pandemic levels.
The findings suggest that while business inflation expectations can become unanchored during severe inflation shocks, they can also be restored through disinflation and clear monetary policy actions. The report concludes that "the experience during the pandemic-era inflation surge suggests that disinflationary dynamics and monetary policy actions can also shape firms' inflation expectations and their perceptions of the Federal Reserve's inflation goal." By the end of 2025, both the levels of sensitivity to current inflation and the differences between small and larger firms' inflation expectations had returned to pre-pandemic levels. The research underscores that persistently elevated inflation can influence how businesses perceive the Fed's goals, but sustained moderation in prices can restore those perceptions and stabilize longer-term expectations.