The focus of monetary policy has shifted markedly over the past 15 years away
from attempts to fine tune the economy towards the longer-run goal of attaining
price stability and creating the necessary conditions for sustainable economic
growth. In an attempt to minimise the costs of such a transition, central banks
have become more independent and monetary policy more transparent, changes
intended to increase the credibility of monetary policy and to reduce short-run
sacrifice ratios. However, concerns have been expressed that an environment of
price stability and independent central banks may instead lead to higher
sacrifice ratios and, perhaps, even higher rates of structural unemployment,
because of the increased importance of nominal and real rigidities at low rates
of inflation.
The purpose of this paper is to analyse whether there are any grounds for such
concerns. We do so by estimating sacrifice ratios for 19 industrialised
countries, using three alternative approaches: (1) estimating aggregate supply
curves; (2) estimating structural price and wage equations; and (3) comparing
actual changes in inflation with changes in standard measures of output and
labour market slack. The empirical evidence shows that, as the average rate of
inflation for the 19 countries in our sample has fallen from 8% to 3½%, the
average sacrifice ratio has increased from around 1.5 to about 2.5. Although
sacrifice ratios appear to have risen in virtually all countries, the increases
tend to be smallest in those that have adopted measures to deregulate labour
and product markets and in countries where the central bank has adopted
explicit inflation targets. However, the empirical evidence also reveals that
point estimates of the sacrifice ratios for individual countries are quite
sensitive to the econometric method adopted. This last result suggests that
identification of the sources of higher sacrifice ratios remains elusive and
thus that one should be cautious about drawing strong implications for monetary
policy from these kinds of estimates.