What is the 'Sacrifice Ratio' in the context of monetary policy?
- The percentage of foreign exchange reserves lost defending a currency peg
- The cumulative loss in GDP required to reduce the inflation rate by 1 percentage point
- The ratio of direct tax revenue sacrificed due to corporate tax cuts
- The difference between the Repo Rate and the Reverse Repo Rate
Answer: The cumulative loss in GDP required to reduce the inflation rate by 1 percentage point
When a central bank aggressively hikes interest rates to crush inflation, it deliberately depresses aggregate demand, which inevitably causes a slowdown in output and a rise in unemployment. The Sacrifice Ratio quantifies the exact macroeconomic 'pain' or lost economic output a nation must endure to achieve a permanent reduction in the underlying rate of inflation.