In this paper we use the information from the Bank of Italy's Survey on Inflation and Growth Expectations to examine the link between Italian firms' inflation expectations and their investment plans. Higher expected inflation stimulates capital accumulation by reducing the cost of loans in real terms; however, the overall effect on investments is made uncertain, a priori, by the interactions that inflation expectations may have with firms’ balance sheet positions (for example, in terms of liquidity and debt levels).
We find evidence of a positive and significant relationship between firms' inflation expectations and their propensity to invest. After controlling for borrowing cost, which is confirmed to be negatively correlated with firms' investment plans, our findings also indicate that the expansionary effect of higher expected inflation is greater for more liquid or more indebted firms.
