Unpacking Central Bank Tradeoffs: Inflation, Output, and Price Levels Post-Pandemic

In the working paper published as Policy Research Working Paper No. 11130 by the World Bank’s Development Economics Prospects Group in May 2025, economists Kristin Forbes (MIT Sloan School of Management, NBER, CEPR), Jongrim Ha and M. Ayhan Kose (World Bank, Brookings Institution, CEPR) deliver a timely and nuanced analysis of how central banks manage competing priorities during monetary policy cycles. The study, developed for the 2025 NBER Macroeconomics Annual, builds on a newly constructed dataset tracking interest rate cycles across 24 advanced economies from 1970 to 2024. It offers new insight into the evolving challenges of inflation control, economic activity management, and public trust, especially in the aftermath of the COVID-19 pandemic.

The Post-Pandemic Puzzle: Minimal Sacrifice, Rising Prices

Central to the study is the paradox observed in the post-pandemic tightening phase. While inflation spiked in 2021–2022 and central banks delayed initial policy responses, many eventually pivoted toward aggressive rate hikes. This approach appeared surprisingly effective, producing historically low “Sacrifice Ratios,” which measure the output loss per unit of inflation reduction. These ratios were close to zero in several countries, suggesting that inflation was curbed with little to no economic pain. However, this narrative omits the significant and cumulative rise in price levels during the same period. While inflation rates returned near target, the overall cost of living remained much higher, fueling household discontent, even in relatively stable economies.

The authors highlight that although traditional models capture short-term disinflation dynamics well, they fail to account for the long-term accumulation of inflation's effects. For example, in the United States, the price level as measured by the PCE index in 2024 was approximately 13% higher than it would have been if inflation had remained at 2%. This surge is comparable only to the inflationary episodes of the 1970s and 1980s, despite occurring in a context of relatively stable employment and GDP growth. The study asserts that while economic indicators may have recovered, real purchasing power did not, an omission that distorts both academic and public interpretations of policy success.

New Metrics for a New Era: Beyond Sacrifice Ratios

In response to the limitations of conventional evaluation tools, the authors propose a novel metric, the Price-Output Tradeoff Ratio. Unlike the Sacrifice Ratio, which only measures the tradeoff between output and inflation, this new ratio evaluates how much of the macroeconomic adjustment burden is borne through changes in the price level rather than output losses. Their findings indicate that, during the post-pandemic tightening phase, most countries relied far more on price adjustments than in past cycles, effectively shifting the cost of adjustment from the labor market to consumers.

While this strategy helped central banks avoid recessions or spikes in unemployment, it left many households worse off. Data from countries like the UK and Germany showed that real wages fell sharply during the post-pandemic period and failed to recover within three years. In contrast, the United States, where nominal wage growth was stronger and fiscal support more expansive, saw a partial rebound in real wages. Still, the broader outcome was a new kind of tradeoff: less output volatility, but at the cost of long-term affordability and higher consumer dissatisfaction.

What Drives Better Outcomes? Credibility is Key

Through regression analysis and simulation modeling using the Federal Reserve’s FRB/US model, the paper examines the factors shaping these tradeoffs. The two central aspects of policy strategy, timing and aggressiveness of rate hikes, produced mixed results. A delayed start to tightening correlated with lower Sacrifice Ratios, but only because inflation was allowed to rise more before policy action began, leading to larger price-level increases. Aggressive tightening, while sometimes effective in suppressing inflation, often came with steeper output losses.

However, the one factor that consistently produced better outcomes across all key metrics, disinflation, output stability, and moderate price-level change, was central bank credibility. Institutions with a history of clear communication, independence, and inflation-targeting frameworks were able to stabilize expectations and navigate post-pandemic challenges with less disruption. The paper underscores that credibility acts as a force multiplier, enhancing the efficacy of both gradual and bold monetary policy strategies.

A Call for Broader Policy Assessment and Communication

The authors conclude with a call for a more holistic framework in central banking, one that gives due weight to price-level effects alongside inflation and employment indicators. They argue that traditional models and central bank mandates have underemphasized the lasting damage caused by cumulative price shocks, even when inflation is brought back to target. Price level increases erode public trust, distort real incomes, and have politically destabilizing effects, as recent elections and polling data suggest.

Going forward, the paper recommends that central banks integrate price-level tracking into their strategic assessments and communication plans. While not advocating for explicit price-level targeting, a complex and potentially confusing regime, they propose that policymakers supplement inflation targeting with clearer explanations of the tradeoffs involved. The post-pandemic period, they suggest, is a wake-up call: achieving numerical inflation goals is no longer enough. Restoring public confidence requires acknowledging and addressing the broader, lived economic impacts of monetary policy decisions.