Which is worse: inflation or unemployment?

You may have missed this wonderfully Josh Zumbrun Wall Street Journal column last week: “Inflation and unemployment both make people unhappy, but perhaps not equally.”

It’s one of those things that’s so obvious that nobody thinks about it — and that’s why we’ve overlooked it for decades.1

Stop for a moment and look at the original misery index Formula invented by the economist Arthur Okun: Add the unemployment rate of 3.7% (BLS NFP) on the inflation rate of 7.7%, as measured by the consumer price index (BLS CPI). The total is 11.4%, as you can see on the diagram aboveis quite high.

Or is it? Should it be?

The Misery Index dates back to the 1970s, a time of high inflation AND high unemployment. And it was a miserable economic time when these two heightened policies combined to create a period of miserable people that the Misery Index captured neatly.

People were unhappy, so the index was correct. But what about the amplitude? As Zunbrun notes: “The Misery Index, as commonly constructed, does not adequately capture how general economic conditions are affecting attitudes.”

So far we have asked an abstract question: what is worse, higher inflationor higher unemployment? The two components of the Misery Index have been treated the same, but we should ask: Should they be? It turns out we never really considered this question. Today, when only one of those two measures is increased, we should.

Forget the academic abstract query and instead ask a person individually what circumstances they would prefer: Would you like to pay more for goods and services, or would you rather be unemployed?

I’ve never considered that until now, but once you’ve done it, the answer is awfully obvious: Of 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 fall in the value of savings, and a drag on GDP. These are all annoyances of greater or lesser magnitude to different people.

But now look at the other half of the index: what happens when you’re unemployed? It’s a terrifying experience that blows a family’s budget, makes people evict, makes people reconsider their own career choices and question their worth; it can even lead to crime.

Zunbrun cites that of Professor Andrew Oswald of the University of Warwick 2001 paper Survey of 300,000 people living in the US. Oswald discovers:

“A 1 percentage point increase in the unemployment rate had the same impact on happiness as a 1.97 point increase in the inflation rate. Mr Oswald said that if he were to create 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 change.

Professor Danny Blanchflower (a friend and occasional fishing chum) looked into this question in 2013-14; What they discovered was more of a 5-to-1 difference:

“Traditionally, we find that both higher unemployment and higher inflation reduce well-being. We also find that unemployment affects well-being more than inflation. We characterize this wealth trade-off between unemployment and inflation with what we call misery relationship. Our estimates using European data imply that a A 1 percentage point increase in the unemployment rate reduces well-being by more than five times 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 impact of the Misery Index, which is directionally accurate but amplitude-wise inaccurate, was evident in recent elections. As I found the day after Midterms:

Inflation? Less important: Rising inflation as the #1 question in polls? The election results strongly suggest that this was wrong. Inflation is important, but so is the broader economy – the unemployment rate, wage increases and fiscal stimulus during the pandemic. In other words, it’s complicated and nuanced, something polls handle poorly.”

The Misery Index is a perfect example of one of those things we take for granted – all too often we just assume something is right; we fail to look closely at the details. It’s a timely reminder that it’s easy to err on broad issues or be fooled by motivated arguments.

Always return to first principles…

UPDATE: November 21, 2022
This is what it looks like when we play around with the ratios, both 2-to-1 and 5-to-1; click rates for FRED charts; Click on the images below for larger diagrams

2 to 1 unemployment to inflation (Oswald)

5-to-1 unemployment to inflation (Blanch flower)

diagrams of Invictus

See also:
The happiness trade-off between unemployment and inflation (JSTOR, Volume 46, October 2014)

Economic uneasiness and consumer sentiment (SSRN Apr 2000)

So far:
When stories collapse (November 18, 2022)

Unconventional Wisdom (November 9, 2022)

What drives 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 to blame for inflation, 1-15 (June 28, 2022)

Inflation and unemployment both make people unhappy, but perhaps not equally
By Josh Zumbrun
WSJ, November 18, 2022


1. Like the Arrow in FedEx logo – but once you point it out, you can never lose sight of it.

Print friendly, PDF & email

Leave a Reply

Your email address will not be published. Required fields are marked *