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Deflation and the Misery Index

February 22, 2012 by Matthew Denhart

Is deflation good or bad for growth? This question complicates reckoning the “Misery Index.” The Misery Index is calculated by adding together the unemployment and inflation rates for a given year. The index was first introduced by the economist Arthur Okun, and it became famous in the 1970s, when the U.S. was suffering simultaneously from high unemployment and high inflation. By 1980 it had reached a peak of 20.27, propelling Ronald Reagan to a landslide victory over incumbent Jimmy Carter in that year’s presidential election. In years when price levels fall, the inflation rate is negative. This means deflation has occurred. If one simply adds a negative inflation rate to the unemployment rate, the overall effect is to decrease the score on the Misery Index. The question then is: Do you agree that deflation is always good for growth? The consensus, from the Federal Reserve on down, is “No.” There are three ways to deal with this statistical complication for years of deflation. Each method can affect a nation’s score, even dramatically, as the year 1932 shows. First, one can simply assume that deflation is good for growth and add this negative inflation rate to the unemployment rate. Doing so makes the Misery Index appear more favorable, by reducing it. For example, in 1932 Herbert Hoover was president and the U.S. economy was in the Great Depression. According to the Historic Statistics of the United States, Millennial Edition, unemployment was a brutal 22.9%. At the same time, prices were falling; the Consumer Price Index indicates an inflation rate of -9.9%. By taking the direct sum of these two figures, the Misery Index for 1932 reads 13.0. Although the American people were suffering, Hoover does not appear too bad by this measure. Conversely, one can treat deflation as a hindrance to growth equivalent to inflation. In this case, one would add the unemployment rate to the absolute value of the deflation rate. Using this method, both inflation and deflation equally contribute to a less desirable Misery Index value. Returning to our 1932 example, under this scenario, President Hoover looks downright terrible with a Misery Index of 32.8. This is quite a difference in score. Finally, one can pass no judgment on deflation, or ignore it, and simply assign a value of zero for price change in years when deflation has occurred. In this instance, the misery index is simply equal to the unemployment rate for the year. For 1932, this method of calculation yields a Misery Index of 22.9. Today’s Misery Index is thankfully much lower than it was in 1932, no matter how it is calculated. But it is still higher than usual, thanks largely to the 2008 financial crisis. According to Bureau of Labor Statistics data and our calculations, the Misery Index stood at 7.45 in 2007, but grew to 9.64 in 2008. In 2009 prices fell slightly, ushering in deflation. As we’ve seen, deflation complicates the Misery Index. If deflation is treated as a positive, the Misery Index for 2009 is 8.94. When deflation is viewed as unfavorable to growth, the 2009 index reads 9.66; when deflation is ignored, it is 9.30. In 2011 the Misery Index climbed to 12.06. However, unemployment rates have fallen in recent months, and the January 2012 data shows the Misery Index has ticked downwards, and currently stands at 11.2.


Author

Matthew Denhart
Matthew Denhart

Matthew Denhart is an expert on immigration policy and is the author of the Bush Institute’s America's Advantage: A Handbook of Vital Immigration and Economic Growth Statistics, now in its third edition. He currently serves as executive director of the Calvin Coolidge Presidential Foundation and is a founder of the Coolidge Scholars Program which provides full-ride merit scholarships to America's most promising college students. A summa cum laude graduate of Ohio University, Denhart has written and spoken widely on a variety of policy topics including the economics of higher education, labor, and taxes. He has contributed articles to numerous national publications including The Wall Street Journal, Forbes.com, CNN Opinion, and Bloomberg View. 

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