The 'Sacrifice Ratio' in the context of the Phillips

Solution

The Sacrifice Ratio is a concept related to disinflation policy. When a central bank wants to reduce the inflation rate (e.g., from 8% to 5%), it typically adopts contractionary policies (like raising interest rates) that slow down economic activity. This slowdown leads to a period of higher unemployment and lower output (or a negative output gap). The Sacrifice Ratio quantifies this cost. It is calculated as the cumulative percentage point loss of Real GDP (or the total unemployment above the natural rate) divided by the percentage point reduction in inflation achieved. It answers: "How much output must we sacrifice to lower inflation by 1%?"