Sacrifice ratio

When a central bank decides to reduce inflation, the question it faces is not just "can we do it?" but "at what cost?" The sacrifice ratio quantifies that cost: how much GDP must be foregone — or how many workers must become unemployed — for each percentage point of inflation reduction. A sacrifice ratio of 2 means reducing inflation by 1 pp costs about 2% of annual GDP cumulatively (or equivalently, roughly 1 pp of unemployment for about 2 years).

The concept was formalised by Arthur Okun and later developed in the empirical work of Lawrence Ball. Historical estimates for the US suggest sacrifice ratios of 1.5–3.0 for major disinflation episodes. The Volcker disinflation of 1979–83 — which reduced US inflation from 13% to 3% — had a sacrifice ratio of approximately 2.5: about 25% of cumulative GDP loss to achieve a 10 pp inflation reduction. In contrast, the 2021–26 disinflation (bringing US inflation from ~9% to ~3.5%) appears to have had a much lower sacrifice ratio — closer to 0.5–1.0 — because GDP stayed positive and unemployment rose only modestly. This is the "soft landing" that was widely considered improbable given historical precedent.

The sacrifice ratio is not fixed — it varies with three key factors:

Credibility: When a central bank announces it will fight inflation and markets believe it, inflation expectations adjust downward rapidly. Wage and price contracts are renegotiated to reflect the new, lower expected inflation. The required output sacrifice is smaller because the expectations channel does much of the disinflationary work. The Fed's 2021–26 episode benefited from its accumulated credibility from the Volcker era and the 2% targeting framework.

Speed and gradualism: Rapid disinflation (as in the Volcker shock) typically has a higher sacrifice ratio than gradual disinflation because it disrupts wage and price contracts before they can adjust. Gradualism allows more time for expectations and contracts to update, reducing the real economy disruption.

Labour and product market flexibility: Economies with more flexible wages (easier to cut or hold flat) and prices face lower sacrifice ratios. Rigid wages mean nominal cuts are replaced by real GDP cuts. The sticky prices and nominal wage rigidities documented in menu cost theory increase sacrifice ratios. Compare the US (relatively flexible) with France or Italy (more rigid labour markets and higher historical sacrifice ratios).

The 2021–26 global disinflation has produced remarkably low sacrifice ratios across advanced economies — especially in the US. Several structural factors helped: (1) supply-side normalisation did much of the work that monetary policy would otherwise have had to do; (2) long-run expectations remained anchored (the 5y5y breakeven never rose above 2.5%); (3) a post-pandemic labour market adjustment reduced employment-population gaps without raising headline unemployment dramatically. The IMF World Economic Outlook has repeatedly revised down recession risk as the disinflation proceeded with minimal output cost.