Which is worse: inflation or unemployment?

You may have missed this wonderful Josh Zumbrun column in the Wall Street Journal last week: “Inflation and unemployment both make you miserable, but maybe not in the same way.”

It’s one of those things that is so obvious that nobody ever stops to think about it, and so we’ve overlooked it for decades.1

Pause for a moment and consider the original Misery Index formula invented by economist Arthur Okun: add the unemployment rate of 3.7% (BLS NFP) to the inflation rate of 7.7% as measured by the consumer price index ( BLS CPI). The total is 11.4%, which as you can see in the chart above, is quite high.

Or is it? It should be?

The Misery Index dates back to the 1970s, a time of high inflation AND high unemployment. And it was a miserable economic time, with both of these high measures together creating a time of unhappy people that the Misery Index accurately captured.

People were unhappy, so directionally, the index was correct. But what about breadth? As Zunbrun notes, “The misery index, as commonly constructed, does not adequately capture how general economic conditions affect attitudes.”

Earlier we asked an abstract question: which is worse, higher inflationor higher unemployment? The two components of the misery index have been treated equally, but we should ask ourselves: They should be? It turns out we never really considered this question. Today, with only one of these two measures elevated, we should.

Forget the abstract academic question and instead ask a person individually which set of circumstances they would prefer: Do you want to pay more for goods and services, or would they rather be unemployed?

I’d never thought about it until now, but once you do, the answer is terribly obvious: Of Obviously 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 curb on GDP. These are all annoyances of greater or lesser proportion to various people.

But now consider the other half of the index: What happens when you’re unemployed? It’s a horrific experience, crushing a family’s budget, getting people evicted, making them reconsider their career choices and second-guess their worth; it can also lead to crime.

Zunbrun cites the 2001 paper by University of Warwick professor Andrew Oswald, which surveyed 300,000 people living in the United States. Osvaldo 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 one simple change: 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 partner) looked into this question in 2013-14; what they found was closer to a 5 to 1 difference:

“We find, conventionally, that both higher unemployment and higher inflation reduce welfare. We also find that unemployment depresses welfare more than inflation. We characterize this welfare trade-off between unemployment and inflation using what we describe as destitution report. Our estimates with European data imply that a A 1 percentage point increase in the unemployment rate lowers welfare by more than five times as much as a 1 percentage point increase in the inflation rate. (emphasis added)

This is an even bigger difference than the original Poverty Index or Professor Oswald’s survey found.

The ramifications of the Misery Index being directionally accurate but inaccurate in terms of breadth have played out in recent elections. As I noticed the day after the midterm:

Inflation? Less important: Rising Inflation as Problem No. 1 in the polls? The election results strongly suggest that this was incorrect. Inflation matters, but so does the economy as a whole: the unemployment rate, wage increases, and fiscal stimulus during the pandemic. In other words, it’s complicated and nuanced, something polls do poorly.”

The Misery Index is a perfect example of one of those things we take for granted: too often we simply assume that something is correct; we fail to carefully consider the details. It’s a timely reminder that it’s easy to be wrong on broad topics or to fool ourselves with reasoned reasoning.

It always comes back to first principles…

UPDATE: November 21, 2022
Here’s what it looks like if we play with ratios, either 2 to 1 or 5 to 1; click reports for FRED charts; click on the images below for larger graphics

2 to 1 from unemployment to inflation (Oswald)

Unemployment 5 to 1 versus inflation (White flower)

charts for invincible

See also:
The Happiness Tradeoff Between Unemployment and Inflation (JSTOR, Vol. 46, October 2014)

Economic hardship and consumer sentiment (SSRN April 2000)

When narratives collapse (November 18, 2022)

Unconventional Wisdom (November 9, 2022)

What is driving inflation: labor or capital? (November 7, 2022)

Behind the Bend, Part V (November 3, 2022)

When Your Only Tool Is a Hammer (November 1, 2022)

Whose Blame Inflation, 1-15 (June 28, 2022)

Inflation and unemployment both make you miserable, but maybe not in the same way
By Josh Zumbrun
WSJ, November 18, 2022


1. Like the arrow in the FedEx logo, but once you point it, you can’t see it anymore.

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