17 June 2022
While there are many economic and sentiment indicators in the modern world, the so-called “Misery Index" is a helpful indicator. Using the combined rate of inflation and unemployment, the index is used to measure people's misery. Even though this sounds a little far-fetched, it is essential to look at the components. How they interact and how the index has fared in the past.
Economist Arthur Okun created the Misery Index in the 1970s to measure the success of presidents and political parties. A former Yale professor, he managed to find the optimum way to reflect the combined effect of unemployment and high inflation on the general public. The fact that his index is still used today, also available with slight variations, reflects the ability to give a snapshot of public sentiment at any moment in time.
Obviously, the greater the level of unemployment, the more misery the public feels, which is reflected in the Misery Index. However, there needs to be a healthy level of unemployment to accommodate a growing economy, but if it is too high, consumer spending will fall, and the economy will struggle.
When looking at the Misery Index, you will notice that the seasonally adjusted unemployment numbers are preferred rather than the headline figures. This obviously provides a more balanced snapshot of unemployment.
While many of us have never experienced deflation or negative inflation, it has occurred in the past. In some ways, this is where the Misery Index fails. If there is relatively high unemployment and deflation, this will reduce the index reading, even though times will be challenging.
As we are experiencing at the moment, high inflation leads to often unaffordable increases in the cost of products and services. The less affordable products and services become the weaker consumer demand, ultimately filtering into job losses, and the vicious circle begins.
While relatively rare, the Misery Index is somewhat disrupted during periods of deflation. It is also important to note that there is a slight lag effect. While inflation will respond relatively quickly to an increase in the price of products and services, unemployment takes a little while to catch up. As we saw in the 1928 depression, the Misery Index was 3.8% in 1929. It then increased to 25.7% in 1933, falling to 23.2% in 1934 and 23.1% in 1935.
In the UK the Misery Index currently stands at 12.8% (unemployment at 3.8% plus inflation at 9%)
Many experts believe that the optimal level for the Misery Index is between 6% and 7%. This relates to what is known as a "Goldilocks economy". A situation where the rate of growth in the economy is controllable, and inflation is at a level which allows for price rises but not unaffordable increases. While debatable, many experts believe that the ideal economic growth rate is between 2% and 3%. For this rate of growth, the Misery Index is broken down as follows:-
The "natural" unemployment rate tends to average between 4% and 5%. This allows enough leeway for companies to recruit staff as they grow in a robust economy. It also ensures a significant element of the public are employed, thereby helping to grow the economy. On the flip side of the coin, relatively low unemployment rates will reduce benefit payments and pressure on government budgets.
While many people may automatically assume that zero inflation is the optimal rate, where the price of services and products doesn’t change, this is wrong. Any economy needs a healthy inflation rate, with the Bank of England and the Federal Reserve targeting 2%. At this level, the price of goods and services can increase at a moderate pace, thereby allowing for wage inflation and increased company profitability.
The Misery Index reading is available going back to 1929 and the appointment of Herbert Hoover as president of the USA. As we touched on above, the great depression of the 1930s saw the Misery Index hit 25.7% in 1933 (unemployment was 24.9% and inflation 0.8%). In more recent times, the US index hit 12.6% in 2009, remaining in double digits until 2011. Before the bull run of the 1980s, the index stood at 19.7% in 1980 as a consequence of a recession.
While the Misery Index is useful for measuring the impact of unemployment rates and inflation on consumers, there is a lag effect. It is perhaps more valuable for short-term traders as a trend indicator and another means of measuring market sentiment.
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