The European Central Bank published a working paper that develops a survey-based framework to quantify what drives euro area firms’ expectations for activity and prices, and concludes that demand-side shocks account for most fluctuations in these expectations while supply-side shocks matter more for pricing. The authors note the paper does not represent the views of the European Central Bank. The study builds composite business expectations indices for manufacturing, market services and construction from European Commission business surveys and shows they have strong predictive power for near-term real GDP growth and GDP deflator inflation. Using sector-specific structural Bayesian vector autoregression models that link expectations to reported constraints, it identifies six structural shocks (product demand, financial conditions and other demand; materials supply, labour conditions and other supply). In the forecast error variance decomposition, demand shocks explain 57% of the variance in activity expectations and 63% in price expectations after one year, with financial conditions more important in manufacturing and construction and labour-related shocks more relevant for services; supply shocks play a comparatively larger role in price expectations, especially during the post-pandemic inflationary period.
European Central Bank 2026-01-28
European Central Bank working paper finds demand shocks dominate euro area business expectations
The European Central Bank released a working paper establishing a survey-based framework to quantify euro area firms' expectations, revealing demand-side shocks primarily drive fluctuations in activity and price expectations, while supply-side shocks significantly influence pricing. The study uses European Commission business surveys to create indices with strong predictive power for GDP growth and inflation, identifying six structural shocks affecting these expectations.