You may have missed this wonderful josh zumbrun column in the Wall Street Journal last week:Inflation and unemployment make you unhappy, but maybe not as much.”
It’s one of those things that’s so obvious that no one ever stops to think about it – and so we’ve neglected it for decades.1
Stop for a moment and consider the original Misery Index formula as coined by economist Arthur Okun: Add the 3.7% unemployment rate (BLS NFP) to the 7.7% inflation rate. measured by the consumer price index (BLS CPI). The total is 11.4%, which as you can see from the graph above is quite high.
Where is it? Should it be?
The Misery Index dates back to the 1970s, which was a time of high inflation AND high unemployment. And it was a miserable economic time, with those two high metrics together creating a period of unhappy people that the Misery Index captured perfectly.
People were miserable, so directionally the index was correct. But what about amplitude? As Zunbrun observes, “The misery index, as it is generally constructed, does not adequately capture how overall economic conditions affect attitudes.”
We have previously posed an abstract question: what is worse, higher? inflationor more unemployment? Both components of the misery index have been treated in the same way, but we should ask ourselves: Should they be? It turns out that we never really thought about this question. Today, with only one of these two high measurements, we should.
Forget the abstract academic question and instead ask a person individually what set of circumstances they would prefer: do you want to pay more for goods and services or would they rather be unemployed?
Interesting question about the components of the misery index: Inflation + Unemployment
Which would you prefer?
— Barry Ritholtz (@ritholtz) November 21, 2022
I had never thought of this until now, but once you have, the answer is awfully obvious: of course people don’t want to lose their main source of income. However you describe inflation, it sucks: a loss of purchasing power, a tax on consumers, a decrease in the value of savings and a slowdown in GDP. These are all inconveniences more or less proportionate to various people.
But now consider the other half of the index: what happens when you are unemployed? It’s a horrific experience, crushing a family’s budget, getting people kicked out, forcing people to reconsider their own career choices and question their worth; it can even lead to crime.
Zunbrun cites University of Warwick Professor Andrew Oswald’s 2001 paper on 300,000 people living in the United States. Oswald discovered:
“A 1 percentage point increase in the unemployment rate had an impact on happiness equivalent to a 1.97 point increase in the inflation rate. Mr. Oswald said that if he were to construct a misery index, he would make a simple modification: Multiply the unemployment rate by two and add it to the inflation rate.” (Emphasis added).
Two for one is a huge adjustment.
Professor Danny Blanchflower (a friend and occasional fishing buddy) looked into this question in 2013-2014; what they found was closer to a 5 to 1 difference:
“We find, conventionally, that higher unemployment and higher inflation reduce welfare. We also find that unemployment depresses well-being more than inflation.. We characterize this welfare trade-off between unemployment and inflation using what we call misery report. Our estimates with European data imply that a A 1 percentage point increase in the unemployment rate reduces welfare by more than five times as much as a 1 percentage point increase in the inflation rate. (Emphasis added)
That’s an even bigger difference than the original Misery Index or Professor Oswald’s survey.
The ramifications of the Misery Index being precise in direction but inaccurate in magnitude have manifested themselves in recent elections. As I noted the day after midterm:
Inflation? Less important: The rise in inflation as the No. 1 issue in the surveys? The election results strongly suggest that this was incorrect. Inflation is important, but so is the overall economy – the unemployment rate, wage gains and fiscal stimulus during the pandemic. In other words, it’s complicated and nuanced, which surveys do poorly.
The Misery Index is a perfect example of one of those things we take for granted – we too often assume something is right; we fail to examine the details closely. It’s a timely reminder that it’s easy to get things wrong on general topics or get things wrong with reasoned reasoning.
Always go back to first principles…
UPDATED: November 21, 2022
Here’s what it looks like if we play with the ratios, both 2 to 1 and 5 to 1; click-through rate for FRED graphics; click on the images below for larger graphics
2 to 1 Unemployment to Inflation (Oswald)
Unemployment rate of 5 to 1 inflation (White flower)
graphics by Invictus
The trade-off of happiness between unemployment and inflation (JSTOR, Vol. 46, October 2014)
Economic Discomfort and Consumer Sentiment (SSRN April 2000)
When Narratives Fall Apart (November 18, 2022)
Unconventional Wisdom (November 9, 2022)
What is driving inflation: labor or capital? (November 7, 2022)
Behind the Curve Part V (November 3, 2022)
When your only tool is a hammer (November 1, 2022)
Who is responsible for inflation, 1-15 (June 28, 2022)
Inflation and unemployment make you unhappy, but maybe not as much
By Josh Zumbrun
WSJ, November 18, 2022
1. Like the arrow in the FedEx logo – but once you point it out, you can’t see it.
#worse #inflation #unemployment #Big #Picture