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?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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