ABSTRACT
Abstract: This chapter explores the output costs of a credible disinflationary program in Turkey. It is shown that a necessary condition for a costless disinflationary path is that the weight attached to future inflation in the formation of inflationary expectations exceeds 50%. Using quarterly data from 1980-2000, the estimate of the weight attached to future inflation is found to be consistent with a costless disinflation path. The chapter also uses structural Vector Autoregressions (VAR) to explore the implications of stabilizing aggregate demand. The results of the structural VAR corroborate minimum output losses associated with disinflation. 1
1. Introduction
Inflationary expectations and aggregate demand pressure are two important variables that influence inflation. It is recognized that reducing inflation through contractionary demand policies can involve significant reductions in output and employment relative to potential output. The empirical macroeconomics literature is replete with estimates of the so-called “sacrifice ratio”, the percentage cumulative loss of output due to a 1% reduction in inflation.
