The Sacrifice Ratio Puzzle

Inflation began rising in 2021 due to pandemic-related supply chain disruptions and reopening dynamics. The Russia-Ukraine war that started in February 2022 intensified these pressures through a commodity super cycle—a broad and sustained surge in energy and raw material prices—that sent inflationary shockwaves to nearly all major economies, including the U.S., where the Consumer Price Index (CPI) inflation peaked at 9.1% in June 2022. However, this event is noteworthy not because of how inflation rose, but rather the manner in which it tapered off, starting in 2023.

Figure 1 illustrates the difference between headline inflation and core inflation. Headline inflation spiked in 2022 and then fell quickly, while core inflation declined more slowly. The source of this data is the Federal Reserve Economic Data (FRED) and author’s own calculations.

When inflation was rising rapidly in 2022, it was predicted that a sustained period of high unemployment would be required to bring inflation back to the Federal Reserve’s 2% target. Such predictions were closely aligned with the findings of the classic Phillips curve, which hypothesizes a trade-off between inflation and unemployment. These predictions were strongly rooted in the sacrifice ratio—the rise in unemployment typically required to reduce inflation by one percentage point. Historical experience suggested that the sacrifice ratio would be substantial, but inflation declined significantly without a notable rise in unemployment. It remained low, fluctuating between 3.6% and 3.9% through 2021 and 2022. The sacrifice ratio turned out to be close to zero.

The big question that these events raise is whether economists overestimated the persistence of supply-side shocks and the sensitivity of inflation to unemployment. Empirical evidence suggests that the Phillips curve was flatter, which would indicate a low sensitivity of inflation to changes in unemployment, and that inflation expectations were strongly anchored around the 2% target (Blanchard and Bernanke, 2023).

The situation developing in 2025–26 is considerably different. As the economy continues to evolve, policymakers and economists are reevaluating their understanding of inflation dynamics. The rapid decline in inflation without a corresponding increase in unemployment challenges traditional economic models and raises questions about the role of inflation expectations and the effectiveness of monetary policy in controlling inflation.

In conclusion, the rapid rise and subsequent decline of inflation in the early 2020s presented a unique puzzle for economists. The low sacrifice ratio and the flattening Phillips curve suggest that traditional trade-offs between inflation and unemployment may not always hold. As the world moves forward, understanding these complexities will be crucial for crafting effective economic policies and maintaining price stability.