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Research Title: Sacrifice Ratio or Benefit Ratio: Controlling Inflation with Tight
Monetary Policy
Student: Sidra Mariyam
Supervisor/Co-supervisor: Dr. Wasim Shahid Malik
Abstract: The primary objective of every public policy is to maximize the welfare of the society.
There are economic policies which control the real and nominal variables of the economy and
enhance the social welfare. Monetary policy is one of such policies: its role is to stabilize output
and along with keeping low and stable inflation. Monetary policy can more effectively manage
short run real stabilization. So main objective of every central bank is to maintain output at its
natural level and keep inflation stable. Whenever output deviates from its potential level then it
will affect inflation in either direction. If actual output is less than potential output it leads to
high prices and vice versa, so central bank should minimize output gap. There are two types of
monetary policies, expansionary monetary policy (loose monetary policy) and contractionary
monetary policy (tight monetary policy). When inflation is very high in an economy central bank
adopts tight monetary policy to control inflation by controlling monetary policy tools (money
supply or interest rate) but when central bank increases interest rate, there is corresponding
decrease in business activity which leads to decrease in output. So there is short run tradeoff
between output and inflation (Philips 1956).