Simple sum of unemployment and (y/y) inflation:
figure 1: The Misery Index is the sum of inflation and unemployment, expressed as a percentage (blue, left scale) and the University of Michigan Consumer Sentiment Index (brown, right scale). Recession dates as defined by NBER are shaded in gray. Source: BLS calculations by FRED, Federal Reserve Bank of Cleveland, University of Michigan, NBER, and authors.
There is no particular reason to give equal weight to inflation and unemployment; instead, Arthur Okun suggests using this particular combination (which he calls the “discomfort index”) as a way of conveying ideas in a simple manner (see Cohen et al. 2014 history). Jimmy Carter then called the measure the “economic misery” index.
How does this relate to how people actually describe their discomfort? A popular measure of economic satisfaction is the University of Michigan Consumer Confidence Index (shown by the brown line in Figure 1). This index is clearly inversely proportional to the suffering index:
UMCSENT = 161.36 – 2.99suffering – 0.022time trend
adjust -R2 = 0.55, SER = 8.405, DW = 0.23, Nobs = 604. bold Indicates significance at 10% msl, using HAC robust standard errors.
There is no particular reason to measure unemployment and inflation equally.
UMCSENT = 161.00 – 2.58inflation – 3.86Not rated – 0.020time trend
adjust -R2 = 0.57, SER = 8.221, DW = 0.25, Nobs = 604. bold Indicates significance at 10% msl, using HAC robust standard errors.
While the INFLATION and UNRATE coefficients do not appear to be particularly different, the Wald test rejects equality at a very high level of significance.
Several interesting aspects of the relationship between the pain index and consumer sentiment.
One is that the relationship is unstable; the Bai-Perron least squares breakpoint test indicated that three breakpoints occurred during the graph.
Second, the importance of unemployment and inflation changes over time, both in terms of slope coefficients and normalized betas. In the last two years, inflation has been increasing.
By the way, both the Michigan Consumer Confidence Index (level) and the Misery Index are poor predictors of recession over the next 12 months (period 1986-2022).
