Expected inflation and the sacrifice ratio

Using inflation forecasts from the OECD Economic Outlook as proxy measures of inflation expectations, we examine the impact of inflation expectations on the sacrifice ratio for 20 OECD countries. The regression analysis considers four different empirical models of the determinants of the sacrifice ratio typically found in the existing literature. The impact of the level of inflation expectations is negative and significant, implying that a higher level of expected inflation is associated with lower sacrifice ratios. This result is consistent with the theoretical role of nominal wage and price rigidities in that reductions in wage and price stickiness diminish the tradeoffs between disinflations and output losses. Interaction effects indicate that higher levels of expected inflation allow policymakers to pursue ‘cold turkey’ inflation reductions even more aggressively. The effect of the change in inflation expectations is negative and significant, implying that faster adjusting inflation expectations are associated with lower sacrifice ratios.