Interpreting economic data - the trade-off between inflation and output: estimating the sacrifice ration.

Inflation has always been a key policy concern for governments. It is generally agreedthat a persistently rising price level causes disruption to the smooth operation of theeconomy and reduces the efficiency of the price mechanism. Moreover bringing downinflation is costly in that it can result in a downturn in economic activity or even anoutright recession. In this article we will examine some of the issues of interest to policymakers using data for the UK economy over the period 1970 to 2002. Our main focuswill be on the measurement of the sacrifice ratio or the loss of output required to bringinflation down from an initially high level. The plan of the article is as follows. In thenext section we discuss the recent economic history of inflation in the UK economy. Weshow how we can obtain a measure of the deviation of output from trend and that there isa clear relationship between this variable and changes in the rate of inflation. Followingthis, we show how we can derive a measure of the sacrifice ratio which will allow us toquantify the costs of bringing down inflation. Finally, we present our conclusions andsome questions for further discussion.