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What Ever Happened
to the Misery Index?
Posted February 2, 2015
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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
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
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?
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?
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
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 . . .
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
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
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)
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
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
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 nonmarket economies like
Venezuela
 Germany and Switzerland
look good because of low
inflation and unemployment
 China looks good because of
high economic growth
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
February 2, 2015 Ed Dolan’s Econ Blog
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
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%
February 2, 2015 Ed Dolan’s Econ Blog
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
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
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February
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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.
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
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February
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2015
Ed Dolan’s
Econ Blog
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