Economics for your Classroom from
Ed Dolan’s Econ Blog
What Ever Happened
to the Misery Index?
Posted February 2, 2015
Ter...
February 2, 2015 Ed Dolan’s Econ Blog
The Misery Index
 While some economists study what makes
people happy, others wonde...
February 2, 2015 Ed Dolan’s Econ Blog
Fifty Years of Okun’s Misery Index
 In the 1960s and 1970s, inflation
in the United...
February 2, 2015 Ed Dolan’s Econ Blog
Can’t We Spice it Up?
 We don’t hear as much about the
misery index these days
 In...
February 2, 2015 Ed Dolan’s Econ Blog
Barro and Hanke Take on the Job
 At least two economists, Robert Barro
and Steve Ha...
February 2, 2015 Ed Dolan’s Econ Blog
Growth of Real GDP
 The idea behind including a measure
of real GDP growth is that ...
February 2, 2015 Ed Dolan’s Econ Blog
Interest Rates
 High interest rates can also make
people miserable
 For example, h...
February 2, 2015 Ed Dolan’s Econ Blog
Real vs. Nominal Interest Rates
 The nominal interest rate can be
broken down into ...
February 2, 2015 Ed Dolan’s Econ Blog
How to Fix the Problem
There are two ways to fix the problem
of double-counting infl...
February 2, 2015 Ed Dolan’s Econ Blog
Three Misery Indexes
We now have three misery indexes:
The Okun index, equal to
une...
February 2, 2015 Ed Dolan’s Econ Blog
The Three Misery Indexes Compared
 The Barro-Hanke index and the UGR
index are more...
February 2, 2015 Ed Dolan’s Econ Blog
Misery by Presidential Term
 Both Hanke and Barrow
measure the amount by which
the ...
February 2, 2015 Ed Dolan’s Econ Blog
Misery Around the World
 This chart compares the
misery index for selected
countrie...
February 2, 2015 Ed Dolan’s Econ Blog
The Bottom Line
 No matter what index is used,
macroeconomic misery in the United
S...
Appendix (1): Real and nominal interest rates
 One key to understanding the effects
of inflation and deflation is the
dis...
Appendix(2): The real rate is the true cost of borrowing
The real interest rate measures the true
cost of borrowing and th...
Appendix (3): The Fisher Principle
 By definition, the nominal rate of
interest is equal to the real rate of
interest plu...
Click here to learn more about Ed Dolan’s Econ texts
or visit www.bvtpublishing.com
For more slideshows, follow Ed Dolan’s...
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What Ever Happened to the Misery Index?

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The original misery index was equal to the rate of inflation plus the rate of unemployment. This slideshow charts the misery index over 50 years and explores modern variants of the index

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What Ever Happened to the Misery Index?

  1. Economics for your Classroom from Ed Dolan’s Econ Blog What Ever Happened to the Misery Index? Posted February 2, 2015 Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.
  2. February 2, 2015 Ed Dolan’s Econ Blog The Misery Index  While some economists study what makes people happy, others wonder what makes people miserable  In the 1970s, economist Arthur Okun developed what he called the misery index, the simple sum of the inflation and unemployment rates  The index is, of course, intended to measure only macroeconomic sources of misery, not illness, poverty, or failed personal relationships Arthur Okun, 1928-1980 Chairman of Council of Economic Advisers, 1968-69; Yale professor, Brookings fellow Photo reproduced under educational fair use exception, intended for classroom use only not to be reproduced
  3. February 2, 2015 Ed Dolan’s Econ Blog Fifty Years of Okun’s Misery Index  In the 1960s and 1970s, inflation in the United States rose from peak to peak  Unemployment failed to decrease when inflation increased, as predicted by the Phillips Curve  As a result, Okun’s misery index soared to record highs  Since that time it has fallen. As the has economy recovered from the Great Recession, it has once again approached 50 year lows
  4. February 2, 2015 Ed Dolan’s Econ Blog Can’t We Spice it Up?  We don’t hear as much about the misery index these days  In an era of chronic low inflation, Okun’s index isn’t miserable enough to make the headlines  Can’t we spice it up a little?
  5. February 2, 2015 Ed Dolan’s Econ Blog Barro and Hanke Take on the Job  At least two economists, Robert Barro and Steve Hanke, have taken on the job of spicing up the misery index  Each has proposed adding other macroeconomic variables that they think make people miserable  Slow growth of real GDP  High interest rates  Do they succeed?
  6. February 2, 2015 Ed Dolan’s Econ Blog Growth of Real GDP  The idea behind including a measure of real GDP growth is that for any given level of inflation and unemployment, people would feel better if the economy is growing rather than stagnant  As this chart shows, the trend in GDP growth has been down over time, offsetting some of the feel-good effect of lower inflation and unemployment compared with the the 1960s and 1970s  The growth variable enters the index with a negative sign, since more growth means less misery
  7. February 2, 2015 Ed Dolan’s Econ Blog Interest Rates  High interest rates can also make people miserable  For example, high mortgage rates make it hard to buy a house  However, there is a problem with including nominal interest rates in a misery index that also includes the rate of inflation . . .
  8. February 2, 2015 Ed Dolan’s Econ Blog Real vs. Nominal Interest Rates  The nominal interest rate can be broken down into two compoents— the real interest rate plus an inflation premium  The real interest rate (nominal rate minus the rate of inflation) is the true cost of borrowing. That is what makes people miserable  If we use R for the nominal interest rate, r for the real interest rate, and π for the rate of inflation, then the real interest rate is defined by the formula r = R- π  Note: for a more detailed discussion of real rates, see the appendix at the end of this slideshow
  9. February 2, 2015 Ed Dolan’s Econ Blog How to Fix the Problem There are two ways to fix the problem of double-counting inflation in a misery index that includes interest rates One is to use an index that is equal to unemployment plus inflation minus growth plus the real interest rate The other is to use unemployment minus growth plus the nominal interest rate (but without counting the inflation rate separately) The two are identical, since the nominal interest rate is equal to the real rate plus inflation
  10. February 2, 2015 Ed Dolan’s Econ Blog Three Misery Indexes We now have three misery indexes: The Okun index, equal to unemployment plus inflation The Barro-Hanke index, equal to unemployment plus inflation minus growth plus the nominal interest rate. (This index double-counts inflation.) The UGR index, consisting of unemployment (U) minus growth (G) plus the nominal interest rate (R) The UGR index is the same as the Barro-Hanke index except that it counts inflation only once (as part of the nominal interest rate)
  11. February 2, 2015 Ed Dolan’s Econ Blog The Three Misery Indexes Compared  The Barro-Hanke index and the UGR index are more volatile than the Okun index, and they show higher maximum levels of misery  However, by and large they show the same general pattern: Poor macroeconomic performance in the 1970s with improvement after that  The global economic crisis of 2008 produced a spike in all three indexes, but not as bad as the 1970s  As the economy has recovered from the Great Depression, misery has approached its historic lows
  12. February 2, 2015 Ed Dolan’s Econ Blog Misery by Presidential Term  Both Hanke and Barrow measure the amount by which the misery index increased or decreased during each president’s term  By the Hanke-Barrow index, Reagan looks very good and Carter very bad, but only because that index double counts inflation  By either index, the Obama administration (through Jan 2015) has produced the greatest reduction in misery
  13. February 2, 2015 Ed Dolan’s Econ Blog Misery Around the World  This chart compares the misery index for selected countries  For international comparison, the Barro-Hanke index gives a better picture because of roblems measuring long-term interest rates in unstable non- market economies like Venezuela  Germany and Switzerland look good because of low inflation and unemployment  China looks good because of high economic growth
  14. February 2, 2015 Ed Dolan’s Econ Blog The Bottom Line  No matter what index is used, macroeconomic misery in the United States has decreased over the past 50 years  The presidents that score best by the misery index are those like Reagan and Obama who were “lucky” to inherit an economy that was very bad when they came into office  The US scores very respectably on the international misery chart  Okun’s original index is still useful, although each index has advantages for particular purposes
  15. Appendix (1): Real and nominal interest rates  One key to understanding the effects of inflation and deflation is the distinction between nominal and real interest rates  The nominal interest rate is the rate stated in the ordinary way, in dollars of interest paid each year per dollar of principal. That is how rates are stated in loan contracts, advertisements, etc.  The real interest rate is the nominal interest rate minus the rate of inflation February 2, 2015 Ed Dolan’s Econ Blog Let . . . R be the nominal interest rate r be the real interest rate π be the rate of inflation Then . . . r = R – π Example: The nominal interest rate is 5 percent and inflation is 3 percent, then the real interest rate is 5% – 3% = 2%
  16. Appendix(2): The real rate is the true cost of borrowing The real interest rate measures the true cost of borrowing and the true return from lending because it takes into account any change in the purchasing power of money between the time a loan is made and the time it is paid back February 2, 2015 Ed Dolan’s Econ Blog Example: I borrow $100 from you and agree to repay $105 at the end of one year, a nominal interest rate of 5 percent Inflation is 3 percent over the year The $105 you receive at the end of the year will buy only as much as $102 bought at the time the loan was made, so in terms of real purchasing power, your return (and my cost) on the loan is 2 percent. February 2, 2015 Ed Dolan’s Econ Blog
  17. Appendix (3): The Fisher Principle  By definition, the nominal rate of interest is equal to the real rate of interest plus the rate of inflation  Other things being equal, the real rate of interest will remain unchanged if borrowers and lenders both expect a change in the rate of inflation  According to the Fisher principle, The nominal rate of interest will adjust so that it is equal to the (approximately constant) real rate plus an inflation premium. February 2, 2015 Ed Dolan’s Econ Blog Example: In year 1, both borrowers and lenders expect 3 percent inflation. They agree to a nominal interest rate of 5 percent, equal to a real rate of 2 percent plus a inflation premium of 3 percent In year 2, both parties expect inflation to be 4 percent, so the agreed nominal rate rises to 6 percent, equal to a real rate of 2 percent plus a 4 percent inflation premium February 2, 2015 Ed Dolan’s Econ Blog
  18. Click here to learn more about Ed Dolan’s Econ texts or visit www.bvtpublishing.com For more slideshows, follow Ed Dolan’s Econ Blog Follow @DolanEcon on Twitter

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