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 agreed that a persistently rising price level causes disruption to the smooth operation of the economy and reduces the efficiency of the price mechanism. Moreover bringing down inflation is costly in that it can result in a downturn in economic activity or even an outright recession. In this article we will examine some of the issues of interest to policy makers using data for the UK economy over the period 1970 to 2002. Our main focus will be on the measurement of the sacrifice ratio or the loss of output required to bring inflation down from an initially high level. The plan of the article is as follows. In the next section we discuss the recent economic history of inflation in the UK economy. We show how we can obtain a measure of the deviation of output from trend and that there is a clear relationship between this variable and changes in the rate of inflation. Following this, we show how we can derive a measure of the sacrifice ratio which will allow us to quantify the costs of bringing down inflation. Finally, we present our conclusions and some questions for further discussion.