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    Question

    If RBI wants to reduce the inflation rate from 6% to

    4%, it often has to slow down the economy, leading to a temporary drop in production. In this context, what does Sacrifice Ratio measure?
    A The percentage increase in employment to reduce inflation by one percentage point. Correct Answer Incorrect Answer
    B The percentage of one year’s Real GDP that must be given up to reduce inflation by one percentage point. Correct Answer Incorrect Answer
    C The amount of foreign exchange reserves lost when the currency devalues due to inflation Correct Answer Incorrect Answer
    D The ratio of people who lose their jobs compared to those who get a salary hike to match the inflation rate of the economy Correct Answer Incorrect Answer
    E The percentage increase in the price of gold when inflation rises, leading to decline in investment in the economy Correct Answer Incorrect Answer

    Solution

    The sacrifice ratio measures the economic cost of reducing inflation, specifically indicating the percentage points of annual real GDP output loss or increased unemployment, required to lower the inflation rate by one percentage point. For example, if an economy has a Sacrifice Ratio of 2, it means that to reduce inflation by 1%, the country must sacrifice 2% of its annual GDP.   Based on Okun's Law, reducing inflation by 1% often requires about 2% of cyclical unemployment.   Sacrifice Ratio is a key tool for central banks to evaluate the impact of contractionary monetary policies on economic growth. 

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