The Cost of Low Inflation in Case of Pakistan

Abstract

Abstract. It is a debatable issue that high and variable inflation causes the well fare loss while on the other side reducing inflation generally has some cost and the amount of that cost is measured by the sacrifice ratio. Therefore inflation output trade off is important for central banks when formulating policy. Sacrifice ratio is the main indicator to measure the real cost of disinflation, calculated as the ratio of the cumulative percentage output loss (the difference between actual and potential output) to the size of disinflation. Thus, the sacrifice ratio measures the real output cost per unit of permanent decrease in inflation. Sacrifice ratio is basically divided into two main categories, time invariant sacrifice ratio and episode specific sacrifice ratio. In time invariant sacrifice ratio we took Philips Curve, structural VAR and in episode specific ratio we took Ball method of sacrifice ratio and Zhang method of sacrifice ratio. We found positive sacrifice ratio in almost all the methods but the magnitude of the sacrifice ratio is not large and the estimates of sacrifice ratio are sensitive to different estimation method. Keywords. Output loss, Sacrifice ratio, Philips Curve, Structural VAR, Potential output, Cost of disinflation, Pakistan. JEL. E31, E52, E59.