Additional Sample (Journal Publication)

December 4, 2022 2:20:05pm WSPC/263-JICEP 2350006 ISSN: 1793-9933 2ndReading
Journal of International Commerce, Economics and Policy

Vol. 14, No. 1 (2023) 2350006 (28 pages)
© World Scientific Publishing Company
DOI: 10.1142/S1793993323500060
Estimations of the Sacrifice Ratio Through Dual Regimes:

An Evidence from Indian Perspective
Devashish Sharma*
Indian Council for Research on International and Economic Relations (ICRIER)
New Delhi, Delhi 110003, India
Sharmadevashish77@gmail.com
Amritkant Mishra
Department of Economics, Birla Global University
Bhubaneswar, Odisha 751029, India
amritkant@gmail.com
Published
This investigation applies a VAR and an ARDL model to estimate the sacrifice ratio in the
period of 1968–2018 subject to two regimes in India. The range for the sacrifice ratio mostly
lies between 0.5 and 1 for the period of 1968–2002 while also experiencing sensitive shifts of
10 and 15. For the period of 2002–2018, the ratio lies between 3 and 5. Furthermore, the
long run estimate of the sacrifice ratio is 2.35 and the short run is 0.35. It is concluded that
the period of 1968–2002 was more sensitive and more prone to disinflationary costs than gains
while the period of 2002–2018 is more resilient and is characterized by both costs and gains to
disinflation. The gains from disinflation for the period of 2002–2018 exceed those of the period
of 1968–2002. In a comparative perspective, the costs to disinflation for India are much less
than the usual range of the sacrifice ratio for advanced economies.
Keywords: Sacrifice ratio; dual regimes; ARDL and inflation.
JEL Classifications: E20, E25, E27, E64, E69
1. Introduction
Sacrifice ratio is defined as the aggregate decline in output associated with one
percentage point decline in inflation (see Fildaro, 1998). Sacrifice ratio thus reveals the
magnitude of the cost of disinflation. There lies a distinction between the usage of the
ratio for advanced economies and emerging ones. For the case of advanced economies,
the sacrifice ratio is often associated with inflation targeting policies, the precedence of
which has increased post the 2007 crises. Inflationary change in advanced economies
is predominantly influenced by interaction of fiscal and monetary policies which
subsequently affect the market behavior. We argue that mechanics of Indian inflation
* Corresponding author.
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D. Sharma & A. Mishra
are subject to more distortions which thus makes the subject of inquiry of the sacrifice
ratio more divulging. Through the documented literature, it can be said that the causes
of the difference in the ratio estimates between the advanced and emerging economies
are primarily attributed to three unusual sources — the sources being immense state
control, sectoral bottlenecks and change in the composition of labor. Rajan and Sub-
ramanian (2006) document the inability of the manufacturing sector to flourish due to a
plethora of constricting laws imposed by the government. Such laws were brought in
place to prevent the emergence of monopolies which would obstruct the emergence of
new players in an economy ridden with a multitude of other problems. Because of such
a litany of laws, the manufacturing make up of India became heavily concentrated in
the small-scale industries (less the 10 workers) while the medium- and large-scale
industries failed to flourish. Another outcome of the same was that while most of the
labor was employed in small-scale labor-intensive industries, there was an increase in
skill-based industries which gave rise to the service class while the manufacturing
sector remained choked. There was thus a stark discrepancy among the manufacturing,
agricultural and the service sector.
Historically, the causes of Indian inflation have also been somewhat unusual when
compared to advanced economies. Joshi and Little (1994) attribute the rise in inflation
Figure 1. Sectoral employment and output shares.

Source: Bosworth and Collins (2015).
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Estimations of the Sacrifice Ratio Through Dual Regimes
for the period of 1970–1980 to the damage inflicted on the agricultural sector by
droughts. While the causes in 1971 were also influenced from other factors such as
the Indo-Pak, influx of refugees from Bangladesh and a halt in the aid being pro-
vided by the US, the causes for 1980 are mostly attributed to the agro sector.
Because of severe droughts, India experienced a fall in agricultural output which
further diffused into the manufacturing sector inflicting a damage again. Within this
period, the monetary policy was also flawed as it lacked the autonomy that it
possesses today. While the monetary policies increased the reserve requirements, an
influx of fiscal policies increased the amount of money in circulation which only
exacerbated the problems of rising inflation. Along with a sectoral divide, there was
also a discordant interplay of fiscal and monetary policy. Lastly, because of the laws
preventing the entry of entrepreneurs in the manufacturing sector, India experienced
a decline in the employment share of the agricultural sector while the skill-based
service class rose. At the same time, the employment share of manufacturing sector
increased diminutively while the output of the same remained almost unchanged.
This further gave rise to the discrepant labour employment pool and a huge chunk of
middle-income levels which prevented graduation into the ranks of high-income
levels (see Anand et al., 2014). Bosworth and Collins (2015) impute the slowdown
in growth in 2010s to the same disparity. It is hard to find sector-wise disaggregated
data for the period before 1996 which is why we focus on aggregate level data to
cater to comparative dynamics. Due to such an unavailability of sector-wise data, we
use two different methodologies to understand the interplay of the above dynamics
across two regimes. The interplay of the fluctuations in three sectors (primary,
secondary and predominantly tertiary) are expected to neutralise when they reveal an
aggregate measure. The need to use two methodologies would somewhat allow us
arrive at robust aggregate estimates just by using overall national and circumvent the
need for sector-based data before 1991. We can thus ensure consistency across
methodologies so that a sector-based analysis wouldn’t reveal drastically different
results when it is aggregated
In the course of our research, we argue how certain factors possibly affect the
changes in the Indian inflation and perhaps lead to unconventional results of the
estimates. There are certain aspects where the this analysis divulges further insight than
the existing literature. First, we analyse a larger sample through an SVAR to be more
comprehensive. Second, we distinguish the sample period on the kind of openness of
the economy. Lastly, we also utilize a Phillips curve approach for the period after
2000s through an ARDL model. We use two approaches (VAR and ARDL) for the
period after 2000s in order to settle the debate of the varying nature of the estimates
subject to the methodology. The ARDL framework is not utilized for the period before
2000s due to a state of extreme state control. The ARDL framework has been theo-
retically built on top of the Phillips curve equation. The Phillips curve is susceptible to
work more efficiently in the period where the state control has declined. Due to such a
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change in regimes, the same ARDL framework is only employed for the period after
2002. We thus employ one empirical strategy of an SVAR for the period before 2002
and two strategies for the period after 2002. The SVAR would provide as a compar-
ative analysis between the two regimes while the ARDL approach would be more
bespoke to the modern perspective of the period of 2002–2018. In order to understand
if the comparative effects of the SVAR’s across regimes are consistent, we also work
with an ARDL for the post-2002 state. Utilizing an additional ARDL would allow for
two things — first, act as a measure of robustness for the SVAR’s as the change of
methodologies also changes the resulting ratios (refer to discussion in literature re-
view); second, it accounts specifically for a more open economic framework where the
constraint of the aforementioned laws do not prevail. Using the same variables would
somewhat add to the uniformity of analysis in order to compare if the effects of the
SVAR approach are in consonance with the Phillips curve approach. The utilisation of
the additional ARDL framework also helps us take into account the aggregate effects
of the removal of economic constraints by circumventing the lack of availability of
sectoral data before 1991 rather than just the theoretical approach focusing on impulse
responses. The ARDL is thus specifically to see how the effects of the reforms have
had an overall effect on the sacrifice ratio in a modern economic perspective. The same
is addressed in more depth in the literature review section. The chronic problem of
high inflation in India has been well documented in many other studies as well. What
hasn’t been largely documented are the costs associated in an attempt to control it.
Especially with the current independence of the central bank, the study of the sacrifice
ratio is more pertinent than ever. There is a difference in the prevailing literature and
the analysis we do. No other literature does a regime-specific analysis with respect to
the pre- and post-2002 era. The decision to do a regime-specific analysis shows how
India has fared in terms of the sacrifice ratio historically and how the same has
changed. The ones that are performed for the period before 1991 are non-parametric in
nature which may cause the results to vary based on different criteria (refer to extended
discussion in literature review). We also use model specifications that are more be-
spoke to the Indian perspective along with two different methodologies in order to
arrive at a robust number for a sacrifice ratio as the literature suggests that difference in
methodologies also may lead to varying results. Finally, we ascribe a range to the
sacrifice ratio instead of a specific number which the other literatures do not strive to
do. Our analysis is thus more robust, comprehensive and bespoke to the Indian
economy as compared to other literature. Through different approaches we utilize, it
would be possible to arrive at a precise measure or range of the estimate in a com-
prehensive way, thus settling a divisive view pertaining to the true sacrifice ratio. In
Sec. 2, we elaborate on the past literature, various methods of estimations, debates and
our preference of some methods over the other. Section 3 offers a brief of the source of
data, their properties and the methodology. While Sec. 4 covers the results and dis-
cussions. Section 5 includes the conclusion.
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2. Literature Review
Bulk of the literature attempts to estimate the sacrifice ratio through a structural VAR
approach. Gordon and King (1982) employ the same using different combinations of
endogenous and exogenous variables for the US economy. They find the estimates to
be between 4.3–5.8 suggesting that a reduction of inflation by 5% would cause a year’s
GNP to fall by 29% ($1000 billion) for a period of 1947–1981. Shapiro and
Watson (1988) utilize a three-variable model which decomposes aggregate demand
shocks into separate individual components through only output, inflation and real
interest rate, excluding any forms of exogenous inputs. Gali (1992) attempts to esti-
mate the same, for the US economy, employing an augmented version of the Shapiro–
Watson system through a four-variable system of output, inflation, real interest rate and
real money supply components. Gali’s estimation can also be viewed as a variant of the
IS-LM model for a post-war USA. In most cases, the estimates for the US economy
through the VAR approach were found to vary between 1–10 although Gali notes that
the inclusion of more variables (four variable system) yields to relatively more im-
plausible and oscillatory results (49 to +68). Another crucial inference that was
drawn from the literature was that the ratio was subject to considerable degrees of
change through the duration of the period, variables included and the estimation
method. For instance, the estimates of Gordon and King were half the amount esti-
mated by Okun for the US economy (1978) even though the difference in time periods
between the studies was just four years. To account for such a degree of fluctuating
estimates, Cecchetti and Rich (1999) use the Shapiro–Watson system, Gali system and
a two-variable system of just inflation and output (Cecchetti system henceforth). The
5-year cumulative output loss as a percentage of real GDP was 1.37, 1.27 and 9.87 for
the two-variable, three-variable and four-variable system, respectively. The estimates
from the Gali equation yield relatively more plausible results in this estimation. One
reason for this could be the added years of data available to Cecchetti and Rich causing
a drastic shift in the estimates similar to the disparity in estimates of Gordon and King
vis-a-vis Okun. Cecchetti and Rich (2001) further refine the same approach by cal-
culating the estimates for different time horizons of the past (quarters) implying the
degree of cost associated with time for the same three systems of equations for the US
economy. The realization of the structural breaks in the series implying that different
sacrifice ratios are associated with different levels of inflation, is of vital importance in
this paper, hence ascribing a greater degree of priority to regime-specific inflation as
exposited by Friedman (1977). Durand et al. (2008) find a relation of a high sacrifice
ratio with a low inflation environment through an SVAR approach for the Euro area
from 1972 to 2003 through both, a sub-period analysis and a 10 year-period rolling
estimate. Coffinet et al. (2007) estimate a ratio of 1.2–1.4% for the Euro area through a
VAR approach, a DSGE and a Phillips curve. A deviation from the conventional VAR
approach is the estimation through different versions of the Phillips curve. Andersen
and Wascher (1999) estimate the ratio for 19 industrialized countries through variants
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of the Phillips curve and infer that the average rate of inflation for the sample decreased
from 8% to 3.5% and the sacrifice ratio increased from 1.5 to 2.5. Ball (1994)
introduces a non-parametric method of estimation specific to episodic disinflation
regimes where episodes of disinflation are recorded through deviations from a vector
moving average of inflation through t n to t þ n lags (n ¼ 4 in quarterly context and
1 in annual context). The estimate is given by the ratio of the hp filtered output gap
upon the difference between the inflation at peak and trough. Ball finds the quarterly
ratio to be 1.4 for an annual measure and 0.8 for quarterly. Bernanke et al. (1999) also
find a similar estimate of 1.3. On the other hand, Mishra (2020) reveals the nexus
between fiscal deficit and food inflation in Indian context with the help of SVAR
method. The outcome reveals that fiscal deficit passes through general inflation finally
leading to a food price surge in the economy. Incorporating Balls method,
Hofstetter (2008) finds astounding results for Latin American countries for episodic
disinflations. The period of 1970s and 1980s find ratios ranging from 0.47 to 0.86
while 1990s experience an anomalous results of negative sacrifice ratios ranging from
0.10 to 0.12 implying an increase in output associated with a reduction in inflation.
In the Latin American context, Hofstetter ascribes the anomalous results to capital
inflows and structural reforms. Similar is the case for the Indian context. Ramachan-
dran and Durai (2012) find sectoral discrepancies in the non-farm and farming sector
through Balls non-parametric approach. They conclude that while the non-farm sector
is more susceptible to a disinflationary cost, the farming sector is associated with a
negative sacrifice ratio (1951–2010). Even though the non-parametric approach is
subject to certain criticism on the basis of the longevity of the effects of inflation
(Zhang et al., 2005), estimation through VARs and the Phillips curve approach do not
tend to dictate different results either. Additionally, Mishra and Agarwal (2019) ex-
amine the nexus between core inflation and economic growth from a global per-
spective. The result of nonlinear granger causality analysis shows that for some
countries core inflation causes economic growth, while on the other hand, in many of
the examined nations, no causality is perceived. Sethi and Acharya (2017) utilize a
VAR and conclude that the sacrifice ratio estimates oscillate around 0.5 to 0.5 in the
service sector, 1 to 2 in the manufacturing sector from 2006 to 2013 and then see an
exponential rise to around 2.5 and 6 post 2013 in the service and manufacturing sector,
respectively. The agricultural sector shows a ratio as low as 15 for 2006 and then
oscillates around 0 from 2008 onwards implying that disinflation is inexpensive, im-
itating a cold turkey situation where disinflation is quick (see Sargent, 1983). Such a
perspective pushes the idea that the existence of a Phillips curve is questionable in
India. While literature suggests that the existence may be questionable (see Rangarajan
and Arif, 1990; Virmani and Kapoor, 2003; Das, 2003a), Paul (2009) concludes the
existence of the same but only through exogenous factors. Dholakia and
Virinchi (2016) analyze the same through a Phillips curve approach and conclude that
the estimates vary between 1.7 and 3.8 subject to the method used and measure of
inflation used. Mitra et al. (2015) deduce through an ARDL framework that the ratio is
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2.8 in an expansionary phase and 2.3 in a contractionary phase. Both Dholakia and
Mitra refute the conclusions by Sethi and Acharya that the cost of disinflation is
negligible in India. There thus exists a dichotomous debate on the cost of disinflation
in the Indian context. The non-parametric approach is specific to episodic disinflation
but the method utilized to define the deviation from the trend inflation is again subject
to debate. There are problems relating to the choice of usage of an hp filter, moving
average or a Baxter King filter. Additionally, Zhang also critiques that the specification
of the lags also changes the results. Because of such problems associated with the non-
parametric method, we only employ a VAR and Phillips curve approach. Both, VAR
and Phillips curve provide more robust estimates than the non-parametric approach
without the requirement of episode specification of disinflation.
3. Data and Methodology

3.1. Data
Most of the studies on the Indian inflation do not account for the period before the
1990s. The studies after the period of 1990s show various estimates of the ratio
between 0.5–2.8 in India (see Rangarajan and Arif, 1990; Virmani and Kapoor,
2003; Das, 2003a; Dholakia and Virinchi, 2016; Sethi and Acharya, 2017). There
also lies a need to be more regime-specific in order to understand the variation in each
state of the economy. A shift in regimes due to different reasons can change the way in
which the endogenous elements vary (see Friedman, 1977). We employ a sample
period of 1968(Q1)–2018(Q4) to account for such various structural shifts.
The ADF tests show that the variables in the sample period of 1968–2002 follow I(0)
processes. Only interest rate and the CPI growth rate for 2002–2018 follow I(1) processes
(see Appendix A). For the VAR methodology, we take the first differences for the two
variables for the period of 2002–2018. An ARDL on the other hand tackles the problem
by accommodating a mixture of variables following I(1) and I(0) processes. The vari-
ables and data source has been given in Table 1.
3.1.1. Structural break test

There exists substantial literature which suggests that India has been subject to various
structural breaks in its growth. Wallack (2003) finds 1980 as the most significant break
Table 1. Description of data.
Variable Source Units
Real GDP growth rate World bank database, OECD USD

CPI growth rate St. Louis Fred Index
M1 supply growth rate St. Louis Fred USD
3-month interest rate Investing.com Percentage
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in India. Panagariya (2004), on the other hand, ascribes a higher degree of significance
to the break in 1991 due to the reforms. Hatekar and Dongre (2005) suggest that the
break of 1950 was the strongest. Bosworth and Collins (2015) suggest another break
around the period of 2010 due to the lagged effects of the 2007 recession. Considering
a model where yt is the independent variable and xt is a covariate, the model can be
represented as
yt ¼ x 0 βj þ ut (t ¼ T(j1)þ1 , . . . , Tj )t
for j ¼ 1, . . . , m þ 1 in a system where there are m number of breaks for implying
m þ 1 regimes. This allows one to estimate an unknown regression coefficient βj for xt
for each time period j when T observations are available. The test includes a maximum
of 5 breakpoints (m ¼ 5). The breakpoints are then given at the point where the BIC
and RSS converge.
We regress the growth rate of GDP on an autoregressive component of one lag.
Accounting for a number of breakpoints, the results are in consonance with all of the
literature. The most significant breakpoints are detected at 1981q2, 2002q4, 2011q2 at
5% significance level denoted by * (see Table 2).
The BIC and RSS both decline till the third breakpoint and then diverge indeed
implying three breakpoints as the most stable ones.
The break point for 1981q2 corresponds to the start of the economic crisis before it
precipitated in 1991. The break date for 2002q4 shows the lagged effects of the policy
measures taken in 1991 leading to an increment in the growth rates. Lastly, the 2011q2
break dates signify the lagged effects of the 2007 crisis (Bosworth and Collins, 2015).
While the data can be split into three subsets based on the break dates, we only choose
to split them into two based on the following reasons.
The focus of our study is predominantly a comparison between a state of dirigisme
with that of a more open economic one in the context of the sacrifice ratio. It is widely
accepted in the prevailing literature that the first decade of the 2000s exhibited a
consistently impressive growth rate unlike the period before it. The prevailing literature
thus establishes two different regimes before and after the period of the 2000s. It is also
known as the pre- and post-LPG (Liberalisation, privatisation and globalisation)
reforms period undertaken by the then Narasimha Rao government in 1991, whose
Table 2. Breakpoints.
Number of breakes Breakdates
M ¼1 2002(Q4)
M ¼2 2003(Q3) 2011 (Q2)
M =3 1981(Q2)* 2002(Q4)* 2011(Q2)*
M =4 1981(Q2)* 1994(Q1) 2003(Q1) 2011 (Q2)
M =5 1976(Q2) 1981(Q4) 1994(Q1) 2003(Q2)
Source: Computed by authors.
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Figure 2. BIC and RSS convergence.

Source: Estimated by authors.
effects were more visible in 2002q4. The breaks owing to the 1981q2 and 2011q4 are
statistically significant but are not within the purview of our exposition.
Dividing the data set between three subsets would also constrict the degrees
of freedom as the resultant split in data would decrease the sample space.
Killian (1998) also points out that smaller samples for vector auto regressions could
lead to relatively more biased estimates and would thus require a removal of the
bias induced. Furthermore, model specifications would be required for each period
which would again complicate the analysis while still being subjected to not too
dissimilar set of regimes. The period from 1968–1981 and 1981–2002 are not too
dis-similar with respect to their output growth rates. The same token is applicable to
the period of 2002–2011 and 2011–2018 as the growth rates are not too dissimilar
in this regime as well.
3.2. Methodology
3.2.1. SVAR specifications and sacrifice ratio estimation
We first elaborate on our specifications for the VAR. A Cecchetti two-variable system
of inflation and output can be represented as follows.
X
p X
p
yt ¼ Ψ i11 yti þ Ψ i12 ti þ " yt , ð1Þ
i¼1 i¼1
X
p X
p
t ¼ Ψ i21 yti þ Ψ i22 ti þ " t : ð2Þ
i¼1 i¼1
Equations (1) and (2) can be represented more conveniently as follows:

y
y "t
Ψ (L) t ¼
t " t
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Yt here denotes stationary output and t denotes stationary inflation at time period t.
θt ¼ [" yt , " t ] representing the vector of innovation processes of aggregate supply (" yt )
and demand shocks (" t ) as per Blanchard–Quah restrictions. θt is assumed to be i.i.d.
N(0, " ) where " denotes the variance covariance matrix of the innovation process.
Ψ (L) ¼ [Ψ ij (L)] where i, j denotes a (2 2) matrix of lagged polynomials.
The literature suggests that the estimate of the ratio might be subject to significant
shifts on the basis of the variables involved, estimation method and time period,
therefore we use more than one equation. Sethi and Acharya use a Cecchetti and
Shapiro–Watson equation for the estimation. While the Cecchetti system is more
generalizable, the Shapiro–Watson equation is more bespoke to the US economy due
to its inclusion of exogenous factor of oil prices which is why it a misplaced choice for
the Indian economy. Keynes suggests that money supply was too sensitive to the
balance of payment in the Indian context (see Roy, 1995). As per Keynes, this leads to
an intrinsic maladjustment between transactions demand for money and money supply
which Keynes considered a major weakness of the Indian economy. This is well
documented by Keynes in his first book “Indian currency and Finance” (1909).
Roy (1995) also documents the Keynesian conjecture while analysing the change in
price movements in the early 20th century India. Thus, including a system which
incorporates inflation, output and money supply would be more pertinent to the Indian
context. Thus, the Keynesian equation model is specified as follows:
2 3 2 y 3
yt "t
4 5 6 7
Ψ (L) t ¼ 4 " t 5
mt "m
t
Mt here denotes the money supply and " m t is the shock due to money supply which can
also be understood as a Keynesian/money supply shock. Lastly, for a more open
economic perspective, the Gali system of equations is utilized which can be viewed as
a variant of the IS-LM model. While the Keynesian and Cecchetti equation provide a
comparison for the evolution of the estimate, it would not be appropriate to disregard
the changes that the economy has been subjected to. The Gali equation would also
account for the changes induced by the variable of interest rate. The Gali VAR is
represented as follows.
2 3 2 " yt 3
yt
6 t 7 6 7
6 "t 7
6 7
Ψ (L)4 5 ¼ 6 i 7:
i t 4" 5 t
mt "t
m
Here, it is the interest rate and mt is money supply. " it is the shock induced by the
changes in interest rate. Thus, a total of three equations following an SVAR meth-
odology is estimated. The Cecchetti and Keynesian equations are estimated for both
the periods of pre- and post-2000 while the Gali system is only estimated for the period
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of 2002–2018. We keep the Gali equations just for the period of post-2000 due to the
lack of dirigisme and more of an open economic state which would allow the interest
rates to function with more autonomy. An overall of 5 VARs are estimated, two for the
period of 1968–2002 (Cecchetti and Keynesian system) and three for the period of
2002–2018 (Cecchetti, Keynesian and Gali system).
3.2.2. Sacrifice ratio

We now expand on the estimation of the ratio subject to the Blanchard and Quah
restrictions. Most of the estimations of the sacrifice ratios through SVARs follow
Blanchard and Quah restrictions (1989) (Cecchetti and Rich, 1999, 2001; Sethi and
Acharya, 2017; Ball, 1994). The Blanchard and Quah restrictions follow the as-
sumption that the output of an economy can be decomposed into its structural demand
and supply disturbances. Assuming a Cecchetti system of inflation and output, the
VAR can be represented as follows.
X
1 X
1
yt ¼ i11 " yti þ i12 " ti ,
i¼0 i¼0
X
1 X
1
t ¼ i21 " yti þ i22 " ti :
i¼0 i¼0
The sacrifice ratio would thus be the difference of change in output upon change in the
rate of inflation. For a horizon of periods (where denotes the lag), the evolution of
the sacrifice ratio can be traced for each period in the system of the VAR based on the
lag specification.
P
@ytþj
j¼0 @" t
SR " () ¼ P ,
@tþ
j¼0 @" t
P
i12
SR " () ¼ Pi¼0
i :
i¼0 22
Cecchetti suggests that i12 represents the cumulative effect of monetary policy shock
on output and i22 represents the impact on inflation due to the same. Estimation of the
ratio implies that the " t innovation process cancels out and leaves the coefficient of the
output to the inflation. Since the individual demand and supply disturbances of " t and
the it elements are unobservable, the ratio is computed by dividing the impulse
response coefficients of output to inflation for each future period .
3.2.3. Phillips curve approach

Andersen and Wascher (1998) utilize various Phillips curves to estimate the sacrifice
ratio for 19 industrialised countries. While the dependent variable is an inflation
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component, an hp filtered output gap is used to measure growth instead of simply the
change in GDP growth rate. The equations comprise the autoregressive component of
inflation along with the lags of the explanatory variables. A point of heavy criticism
here is that Andersen and Wascher do not follow the ARDL framework. There is a
theoretical justification that accounting for certain autoregressive components and
distributed lags accounts for nominal rigidities but no statistical robustness is the same.
This leads us to question that the equations might suffer from heavy endogeneity
leading to spurious results. We thus utilize the Andersen and Wascher specification of
a Phillips curve but in an ARDL set up. The optimal ARDL specification would be of
the order (p, qi ) where p denotes the lags of the autoregressive component and qi
denotes the specification of the distributed lags of each explanatory variable i. We
define the Phillips curve unrestricted ARDL as follows:
X
p
t ¼ α þ α1 ti þ α2 iti þα3 y
ti þ α4 mti þ 1i Δti
i¼0
X
q1 X
q2 X
q3
þ 2i Δiti þ 3i Δy
ti þ 4i Δmti þ "t
i¼0 i¼0 i¼0
t here is the growth rate of CPI, y t is the hp filtered output gap, mt is the money
supply and it is the interest rate on three-month government bonds at time period t. The
ARDL lag specification would thus be of the order (p, q1 , q2 , q3 ). Once the unrestricted
model is estimated, a bounds test is performed to check for a long run relationship as
specified by Pesaran et al. (2001). If a cointegrating relationship has been established,
the long run form can be estimated as follows:
X
p X
q1 X
q2 X
q3
t ¼ α þ δ1 ti þ δ2 iti þ δ3 y
ti þ δ4 mti þ "t :
i¼0 i¼0 i¼0 i¼0
Subsequently, the restricted short run error correction model can be estimated as
follows:
X
p X
q1 X
q2 X
q3
Δt ¼ 1i Δti þ 2i Δiti þ 3i Δy
ti þ 4i Δmti þ ecmt1 þ "t :
i¼0 i¼0 i¼0 i¼0
Here, is the error correction term that denotes the speed of adjustment back to
equilibrium. In most Phillips curve approaches, the ratio is given by dividing the
coefficients of inflation to output. The advantage here is that in the case of a coin-
tegrating relationship, we can establish two estimates of the ratio, one for the long run
and one for the short run for the period of 2002–2018. The lag length is estimated
primarily through one of the three different criteria. Namely, Akaike information cri-
terion, Hannan–Quinn criterion and the Schwarz information criterion. While these aid
in the selection of optimal lags, the estimates of each often do not coincide. To arrive at
an optimal level, we utilize all the three and also the final prediction error.
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The selection of the optimal lag through different methods provides the basis for
potential models. This also disregards the precedence of one criterion over the other. In
the preliminary analysis, the choice of the optimal lag for the models would yield
serially correlated errors as denoted by the BG test. Thus, we utilize not only the lag
selection criterions but also take into account the degree of error correlation and
stability associated with the models for different lags. The lags chosen above provide a
VAR estimation which is stable with serially uncorrelated errors (see appendix).
Killian and Luktepohl (2017) suggest that models dealing with quarterly observations
tend to have lags between 4–8 which are more closely exhibited by the equations in the
sample period of 2002–2018. The optimal lags thus reveal a distinction between the
two sample period divisions. The period before 2000s is characterised as highly
sensitive and uninsulated to shocks. Moreover, rapid corruption, inequality, political
instability and wars contributed to a perpetual state of shocks. The lag orders for 1968–
2002 are more than what is conventionally observed for a VAR but it is highly
plausible that the slightest shocks would cause significant change in the economy which
would persist for a long time. It is possible that such shocks would persist for over 3 years.
We address the same in more depth in the Results section through the IRFs.
4. Results Analysis
We now address some issues pertaining to the division of my sample data. Panagariya
suggests that the period of 1980–1991 is often characterised as a period of extreme
volatility in the Indian economy while the period of 1991–2000 experiences a rela-
tively smoother growth. The Indian literature widely accepts that there exists a
remarkable distinction before and after the period of 2000. A pre-2000 India is clas-
sified more through a state of dirigisme while that of post-2000 entails a more open
economic structure. Moreover, the reforms were a gradual process starting in 1980 till
1991 while the effects were palpable only after 2000. This would thus be classified as a
state-conditioned period. We infer three breakpoints and thus four regime shifts but in
order to be more parsimonious, they are divided through a pre-2000 and post-2000
India. Another reason why classifying each regime seems unfeasible is that it might
constrain the degrees of freedom due to limited observations while the insights would not
yield particularly divulging results specifically for two samples of the pre-2000 period. The
first sample ranges from 1968(q1) to 2002(q4) and the second one from 2002(q1) to
2018(q4) (as specified by the breakdate). Our analysis thus focuses on a pre- and post-2000
India distinguishing between a state-controlled economy and a more open economic one.
4.1. SVAR ratio estimates

Tables 3 and 4 represent the estimates of the ratio for a combination of lags for all the
equations across the two sample periods. denotes the future horizons and thus the
evolution of the ratio for 20 periods.
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Table 3. Estimates 1968–2002.
Equation =2 =4 =8 = 12 = 16 = 20 Cumulative
Cecchetti 0.19 0.30 1.06 0:22 0.38 0:16 3.04

Keynesian 0.20 0.34 0.06 0:34 0:06 1:86 0.5
Table 4. Estimates 2002–2018.
Equation =2 =4 =8 = 12 = 16 = 20 Cumulative
Cecchetti 1.24 0.46 0.36 0.21 0.07 0:02 4.5

Keynesian 0:50 0.73 0.69 0.21 0:09 0:34 5.3
Gali 1:4 0:82 1.08 0.73 0:22 0:71 1.58
There is a stark distinction in the two equations for the two sample periods. The
estimates of the Cecchetti and Keynesian equations for the period of 1968–2002 reveal
cumulative ratios of 3.04 and 0.5, respectively, which rise subsequent to the period to
4.5 and 5.3, respectively. This implies that the costs to disinflation have increased over
the two sample periods as per the Cecchetti and Keynesian equations. The Gali
equation on the other hand reveals a lower sacrifice ratio of 1.58. One possible ex-
planation for the same could be that due to the inclusion of interest rates, the Gali
system of equations is perhaps more resilient than Cecchetti and Keynesian ones. This
also establishes that the tool of interest rate is perhaps a very strong one for the Indian
economy. There are instances of negative ratios for certain periods which are not
characteristics of advanced economies. The trends for the ratios are more clearly
visible in the graphs below. The range of the ratio for the Cecchetti equations has
increased over the two periods specifically showing significant amounts of negative
ratios in the period of 2002–2018. The change in the range between the two periods is
not too drastic. The Keynesian equation for 1968–2002 mostly tends to move around 0
but also experiences significant rise and declines (15 to 10). Sethi and Acharya also
record a similar decline of 15 in their sacrifice curves especially for the agro sector.
There is a significant rise in the Keynesian equation for the period of 2002–2018 in the
beginning but then it again subsides and oscillates around 0. This movement around 0
is exhibited in both the periods of the Keynesian equation. An inference here is that
while the Keynesian system is not as fluctuating as the Cecchetti system, it experiences
more extreme costs and gains to disinflation than the Cecchetti system. This can also
lead us to infer that the Keynesian system is more sensitive than the Cecchetti system.
The range of the Gali sacrifice curve is more than Cecchetti and the Keynesian (ex-
cluding outliers) and also seems to be more fluctuating. This also implies that both the
costs and gains to disinflation are more in the current scenario.
2350006-14
Figure 3. Cecchetti equation ratio estimates.

Figure 4. Keynesian equation ratio estimates.

Figure 5. Sacrifice curve for Gali equation.

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A negative sacrifice ratio is anomalous for more advanced economies due to their
lack of constraints vis-à-vis the emerging ones. The same is not true for developing
economies due to their demographic composition and state restrictions as illustrated by
Hofstetter (2008) for Latin American countries. Zhang (2005) also finds negative
sacrifice ratios but also infers that they don’t persist for long. Specific to the context of
India, there exists a large amount of population employed in the agricultural sector
(50%). This figure was even more than what it currently is in the period of 1968–2000.
One possible explanation for a larger estimate of the sacrifice ratio in the same period
could be because a disinflationary effect would translate into lowering the price of raw
materials and thus incentivizing more production in the agricultural sector. In such a
way, the effects of disinflation that befell the agricultural sector would outweigh the
effects borne by the service and manufacturing sector. Certain instances of a positive
sacrifice ratio could also imply the undue cost borne by the manufacturing sector which
remained relatively more choked due to heavy import restrictions and government
policies. The MRTP act restricted the setting up beyond a certain turnover (see
Das, 2003b; Rajan et al., 2006). Declines of import tariffs by a measure of almost 300%
were estimated from 1991 through 1999. As the results from the Keynesian system are
more sensitive, they allude to significant costs to disinflation through the period of
1968–2000. There are both costs and gains observed to disinflation. Stiglitz (1997)
suggests that beyond the endogenous factors of unemployment and output affecting
NAIRU, a significant one is that of the labour composition. Through the period of
1968–2018, there has been a significant change in the amount of labour employed in
each sector in India. The employment has consistently declined in the agricultural sector
and has increased in the service sector. The share for manufacturing has more or less
remained the same due to constricting labour laws (Bhagwati and Panagariya, 2013). A
diffusion of labour into the service sector has therefore made the economy more re-
silient which explains the decline in the estimates of the Cecchetti and Keynesian
equation. The period of 2000–2018 is not unconstrained from the interplay of sectoral
disinflation but the effects do stand reduced by a significant amount in relation to the
ones exhibited by the pre-2000 regime. Literature suggests that sectorally, the agri-
cultural sacrifice ratio estimates were mostly negative which may outweigh the overall
effects thus translating into negative estimates at certain instances (Sethi and Acharya,
Ramachandran). Romer (1993) ascribes the degree of openness of the economy to
changes in inflation as well. The Indian economy experienced the effects of openness
only after 2000 as the amount of imports witnessed an exponential rise. There might
also be an interplay of the openness and a change in sectoral labour employment which
may have led to such estimates especially in the context of the Gali equation. A more
independent central bank has the ability to govern with more freedom than it did before.
It is because of an advantage of interest rates that the estimates show a decline in
comparison to the cumulative rise shown by the Cecchetti and Keynesian set up. In
order to explain the difference in the estimates in the two periods, we juxtapose the
2350006-16
impulse response functions for the Cecchetti and Kenesian equations for both time
periods for a comparative summary.
4.2. Impulse responses

The IRF’s for the Cecchetti equation in Fig. 6 show interesting results. The period of
1968–2002 exhibit a smooth rise and decline for shocks, especially inflation. The same
is not visible for the period after 2000. All of the shocks of the Cecchetti system in the
period after 2000s tend to not be as fluctuating as the period before. Shocks to the first
regime denote a greater sensitivity and thus it is not resilient to shocks. It is plausible
that such a state of dirigisme might have led to the estimates of the ratio to be
Figure 6. Impulse responses for Cecchetti equations.

2350006-17
so sensitive. While the response functions for 1968–2002 follow more of a hump shape
which is typical of real variables, the period of 2002–2018 tend to not be as responsive
to shocks. There is thus a transition noted from a sensitive to a more resilient state of
the economy. There is an apparent decline in the degree of responsiveness to shocks for
both inflation and output through 1968–2002. This again can be ascribed to two major
reasons of labour diffusion from the agricultural sector to the service sector and a more
open economic state.
The Keynesian system of equations in Fig. 7 offers a more apparent distinction. The
variables for the period of 1968–2002 again show a relatively higher degree of variance
in their responsiveness to the shocks as compared to the period of 2002–2018. The
impulse responses for the first regime again follow a more hump-shaped response
while the second regime exhibits more fluctuating results but with a significantly less
degree of variance. The Keynesian conjecture states that the Indian economy suffers
from an inherent maladjustment between transactions demand for money and its
supply. The way in which M1 component of the economy responds to shocks for both
regimes does in fact show a certain degree of maladjustment. While there is an ap-
parent distinction in the way GDP and CPI respond to shocks in both regimes, the
responsiveness of the M1 component is similar in both. This perhaps also denotes that
the Keynesian conjecture is also valid for the Indian economy in the modern context.
The inference we draw here is that a three-variable model provides a better basis to
distinguish between the state of affairs of the Indian economy in the two periods than a
two-variable model.
The results for the Gali equation in Fig. 8 reveal yet another perspective different
from the one divulged by the Keynesian and Cecchetti equation. One important factor
to consider here is that in the Gali system, all the variables seem to converge within 20
quarters after the shock. The IRFs imply that including a system with three-month
interest rate would in fact lead to convergence. The Keynesian and Cecchetti equations
exhibit persistent shocks with different degrees of variance but none of them achieves
convergence for either time periods. Thus, it would not be inappropriate to infer that
interest rate is in fact a very powerful tool of monetary policy in the current Indian
context.
4.3. ARDL Phillips curve estimates

The AIC suggests the optimal lag orders for the ARDL as (2,4,4,2). The F statistic for
the bounds test is greater than the upper bound suggesting possible cointegration (see
appendix). Thus, it is established that there is both a long-term and a short-term
relationship. Since the topic of inquiry is the sacrifice ratio, we report the estimates of
the ARDL, unrestricted and restricted error correction model in the appendix. Since the
optimal model detects the two lags for the dependent variable, the estimation of the
ratio gets restricted to not beyond two lags. We report the long-run and short-run
estimates as per the Wascher Andersen specification where we divide the coefficients
2350006-18
Figure 7. Impulse responses for Keynesian equations.

2350006-19
Figure 8. Impulse responses for Gali equation 2002–2018.

of inflation by the coefficients of output for the first lag each. Moreover, the estimates
for the second lag are not statistically significant (see appendix).
We infer that both the long-run and short-run ratios are characterized by gains to
disinflation (Table 5). The long run particularly establishes more gains than the short
run. The Phillips curve approach thus suggests that the current Indian economy is
characterized by more gains to disinflation in the long run than in the short run.
Another inference here is that the estimates lie well within the ranges established by
Table 5. Phillips curve sacrifice ratios 2002–2018.
Model Sacrificing ratio (t1 =yt1 )
ARDL (long run) 2:35

VECM (short run) 0:225
2350006-20
the estimates of the SVARs. This also establishes the validity of the Phillips curve
approach along with the SVARs.
5. Conclusion
The evolution of the sacrifice ratio certainly shows a lot of change. The sacrifice curves
for the pre-2000 Cecchetti system show that the ratio ranges between 0.5 and 1
implying more amount of costs to disinflation than gains. The pre-2000 Keynesian
sacrifice curve also shows that while the ratio mostly tends to stick to 0, it experiences
instances of both, diametric costs and gains (15 to 10). We thus infer that the period
of 1968–2002 was more sensitive and experienced more costs to disinflation within a
range of 0.5–1 (excluding outliers). The period after 2002 shows that while the costs
have increased, the gains to disinflation have increased as well. The range for the
sacrifice curve for all the three equations lies between 3 and 5. In the long run, the
post-2000 economy experiences more gains to disinflation (2.35) than in the short
run (0.22) as per the Phillips curve approach. Another crucial inference in the course
of my inquiry is that it is easier to quantify the sacrifice ratio in a range than a specific
number due to different regimes and methods of estimations. Quantifying the sacrifice
ratio to a number would imply that the slightest deviation from a particular estimate
would lead the economy to function at a level where it may experience more gains than
usually perceived or a sub-optimal one. It may lead to a problem of false positives and
negatives. Establishing a range is not as restrictive as establishing an estimated number
and would also give a clearer picture of the dynamic natural levels of the sacrifice ratio.
Any deviation beyond the established range would imply reasons to be concerned in
the context of the monetary policy. The results of our analysis are also consistent with
the existing literature which analyse the sacrifice ratio for the period after 2000 i.e.,
between 0.5–2.8. A crucial inference in our results, which is not centric to advanced
economies, is that disinflationary costs are also subject to change if the state is more
controlling. It is because of this state control that the disinflationary costs were so
sensitive during the period of 1968–2002. The central bank did not have as much
independence before 2000 as it has now, which puts the sole onus of disinflationary
measures on fiscal policies for the period of 1968–2000. Given that the Indian
economy was not as open as it is currently, any measure of disinflation by the state
would burden the already encumbered manufacturing before 2000. Along with this, the
agricultural sector would experience a gain since costs are driven down which might
also explain the large potential gains to disinflation. Due to severe constraints and
inequalities in the sectoral employment and chronic problems of poverty, corruption
and political instability, the period before 2000 was subject to diametric costs and gains
to disinflation which only exacerbated problems for India. As the central bank gained
more independence after the period of 2000, these large fluctuations subsided and
became more pliable. While the sacrifice ratio is mostly associated with matters per-
taining to inflation targeting, we also conclude that the same can be associated with
2350006-21
matters of state control in the context of developing economies. Since the current state
of the Indian economy is unequivocally much better than it was, it makes the sacrifice
ratio more pertinent now especially since flexible inflation targeting was introduced in
2016. An aspect where India has more edge than advanced economies is that the tool
of interest rate still holds a significant command over the economy as the IRFs for the
Gali equation denote. The chances of the interest rates hitting a zero lower bound are
also unlikely because of the mixed nature of sectoral labour composition which in
some way strengthens the inflation targeting policy even more. In a comparative
perspective, the costs to disinflation for India (3 to 5) in the current context are much
less than advanced economies (1–10). We thus conclude that the range of the sacrifice
ratio for the period of 1968–2002 lies between 0.5 and 1 with instances of diametric
shifts while the period of 2002–2018 has a range of 3 to 5.
Appendix A
Table A.1. ADF test unit root test.
Variable At level First difference Transformation required
GDP growth rate (1968–2002) 5:423*** — None

CPI growth rate (1968–2002) 3:897*** — None
M1 (1968–2002) 5:255*** — None
GDP growth rate (2002–2018) 4:53** — None
CPI growth rate (2002–2018) 1:132 3:50** First difference
M1 growth rate (2002–2018) 4:3902*** — None
Interest rate growth rate (2000–2018) 2:478 3:77** First difference
Notes: *, **, *** denote significance at 10%, 5% and 1% level, respectively. Estimated by authors.
Figure A.1. CUSUM plots of Cecchetti VAR (1968–2002). Estimated by authors.
2350006-22
Figure A.2. CUSUM plots of Cecchetti VAR (2002–2018). Estimated by authors.
Figure A.3. CUSUM plots of Keynesian VAR (1968–2002). Estimated by authors.
2350006-23
Figure A.4. CUSUM plots of Keynesian VAR (2002–2018). Estimated by authors.
Figure A.5. CUSUM plots of Gali VAR cusum. Estimated by authors.
2350006-24
A.1. ARDL estimates and diagnostics
Table A.2. Bounds test.
Test statistic Value Significance I(0) I (1)
F-statistic 5.20 10% 2.37 3.2

K 3 5% 2.79 3.67
2.5% 3.15 4.08
1% 3.65 4.66
Notes: *, **, *** denote significance at 10%, 5% and

1% level, respectively. Estimated by authors.
Table A.3. ARDL coefficients.
Variable Coefficient Standard error
t1 0.73*** 0.12

t2 0.18 0.12
~yt 0:54*** 0.17
~yt1 0:31* 0.18
~yt2 0:20 0.16
~yt3 0:21 0.16
~yt4 0:38** 0.16
it 0.13 0.21
it1 0.24 0.21
it2 0.48** 0.21
it3 0:57** 0.21
it4 0:58** 0.22
mt 0.05 0.05
mt1 0.06 0.04
mt2 0.10* 0.05
Constant 0:09 0.51
Notes: *, **, *** denote significance at 10%, 5% and

1% level, respectively. Estimated by authors.
Table A.4. VECM coefficients.
Δt1 0:18* 0.11

Δ~yt 0:54*** 0.15
Δ~yt1 0.80*** 0.20
Δ~yt2 0.59*** 0.17
Δ~yt3 0.38*** 0.13
Δit 0.13 0.16
2350006-25
Table A.4. (Continued )
Δit1 0.67*** 0.24

Δit2 1.15*** 0.25
Δit3 0.58*** 0.20
Δmt 0.05 0.03
Δmt1 0:10** 0.03
Cointegrating equation (t 1) 0:08*** 0.01
Notes: *, **, *** denote significance at 10%, 5% and 1%

level, respectively. Estimated by authors.
Table A.5. Error correction coefficients.
~yt 19:76 12.07

it 3:54 7.31
mt 2.72 2.15
Notes: *, **, *** denote significance at 10%, 5%

and 1% level, respectively. Estimated by authors.
Figure A.6. ARDL CUSUM plots. Estimated by authors.
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December 4, 2022 2:20:05pm WSPC/263-JICEP 2350006 ISSN: 1793-9933 2ndReading

Journal of International Commerce, Economics and Policy

Estimations of the Sacrifice Ratio Through Dual Regimes:

Keywords: Sacrifice ratio; dual regimes; ARDL and inflation.

JEL Classifications: E20, E25, E27, E64, E69

D. Sharma & A. Mishra

Figure 1. Sectoral employment and output shares.

Estimations of the Sacrifice Ratio Through Dual Regimes

D. Sharma & A. Mishra

Estimations of the Sacrifice Ratio Through Dual Regimes

D. Sharma & A. Mishra

Estimations of the Sacrifice Ratio Through Dual Regimes

3. Data and Methodology

3.1.1. Structural break test

Table 1. Description of data.

Variable Source Units

Real GDP growth rate World bank database, OECD USD

D. Sharma & A. Mishra

Number of breakes Breakdates

Source: Computed by authors.

Estimations of the Sacrifice Ratio Through Dual Regimes

Figure 2. BIC and RSS convergence.

Equations (1) and (2) can be represented more conveniently as follows:

D. Sharma & A. Mishra

Estimations of the Sacrifice Ratio Through Dual Regimes

3.2.2. Sacrifice ratio

3.2.3. Phillips curve approach

D. Sharma & A. Mishra

Estimations of the Sacrifice Ratio Through Dual Regimes

4.1. SVAR ratio estimates

D. Sharma & A. Mishra

Table 3. Estimates 1968–2002.

Cecchetti 0.19 0.30 1.06 0:22 0.38 0:16 3.04

Source: Estimated by authors.

Table 4. Estimates 2002–2018.

Cecchetti 1.24 0.46 0.36 0.21 0.07 0:02 4.5

Source: Estimated by authors.

Estimations of the Sacrifice Ratio Through Dual Regimes

Figure 3. Cecchetti equation ratio estimates.

Figure 4. Keynesian equation ratio estimates.

Figure 5. Sacrifice curve for Gali equation.

D. Sharma & A. Mishra

Estimations of the Sacrifice Ratio Through Dual Regimes

4.2. Impulse responses

Figure 6. Impulse responses for Cecchetti equations.

D. Sharma & A. Mishra

4.3. ARDL Phillips curve estimates

Estimations of the Sacrifice Ratio Through Dual Regimes

Figure 7. Impulse responses for Keynesian equations.

D. Sharma & A. Mishra

Figure 8. Impulse responses for Gali equation 2002–2018.

Table 5. Phillips curve sacrifice ratios 2002–2018.

Model Sacrificing ratio (t1 =yt1 )

ARDL (long run) 2:35

Source: Estimated by authors.

Estimations of the Sacrifice Ratio Through Dual Regimes

D. Sharma & A. Mishra

Table A.1. ADF test unit root test.

Variable At level First difference Transformation required

GDP growth rate (1968–2002) 5:423*** — None

Figure A.1. CUSUM plots of Cecchetti VAR (1968–2002). Estimated by authors.

Estimations of the Sacrifice Ratio Through Dual Regimes

Figure A.2. CUSUM plots of Cecchetti VAR (2002–2018). Estimated by authors.

Notes: , , denote significance at 10%, 5% and

Notes: , , denote significance at 10%, 5% and

Notes: , , denote significance at 10%, 5% and 1%

Notes: , , denote significance at 10%, 5%