Which makes us more miserable: inflation or unemployment?

April 12, 2013

When people grumble about the bad economy, they are often referring to one of two things: rapid inflation or  crippling unemployment.

In the late 1970s, the country was suffering through both. That period of “stagflation” led many economists to believe that unemployment and inflation were equally bad for the economy. Legendary economist Arthur Okun even devised a “misery index” that simply added the two together to create an indicator of how much Americans were suffering.


Gas lines like these were a problem in the era of stagflation. But does unemployment or inflation really make people more miserable?

But lately some economists have questioned that assumption. Both inflation and unemployment are undesirable, but is one more harmful to the nation than the other? Did Okun's misery index, which weights them equally, get the ratio wrong?

Dartmouth College professor David G. Blanchflower and three colleagues attempt to break down the degrees of misery during bad economies in a new paper to be presented Friday at the Federal Reserve of Boston’s annual research conference. Blanchflower introduces  a “misery ratio” to compare the awfulness of unemployment to the pain of inflation. He  relies on surveys of well-being across Europe to determine exactly how bad people felt during periods of high unemployment versus periods of high inflation.

And the surveys show .... [insert drum-roll]: Unemployment feels worse. Way worse.

Blanchflower’s calculations show that a one percentage point increase in the unemployment rate lowered our sense of well-being by nearly four times more than a one percentage point rise in inflation. In other words, unemployment makes people four times as miserable.

The reason, Blanchflower argues, is that unemployment not only affects those who have lost their jobs. It also generates fear among that person’s family, friends and neighbors over their own job security. The unemployed person may also turn to them for financial or other help, further affecting their well-being.

Such findings could have significant implications for monetary policy, which until the most recent recession has primarily been concerned with controlling inflation. But now some central banks are speaking of allowing inflation to rise or stay slightly above their usual targets in hopes of bringing down unemployment. The Federal Reserve, for example, has said it will keep low interest-rate policies in place until either unemployment falls significantly or inflation is set to rise above 2.5 percent. That implies the Fed would tolerate inflation above its usual 2 percent target as the price to pay for getting more people back to work.

“Our estimates of the misery ratio suggest that this is the correct approach if the objective is to maximise national well-being,” Blanchflower writes in his paper.

Of course, not everyone agrees. In the United States, several leading economists and even some Federal Reserve officials have warned repeatedly that the past five years of easy-money policies could be sowing the seeds for damaging inflation down the road.

Others, like Boston Fed President Eric Rosengren, argue that the central bank is obligated to do more to bring down the jobless rate. Congress tasked the Fed with responsibility for maintaining price stability and supporting maximum employment. And it is missing by a long shot on jobs.

“In the more recent past we may have placed too little weight on unemployment misses,” Rosengren said in a speech this morning in Boston, according to prepared remarks. “If anything, we should have acted more aggressively to reduce the unemployment rate.”

Rosengren’s remarks carry particular weight because the Fed has begun floating the idea of dialing back its $85-billion-a-month bond purchases to stimulate the economy. (Rosengren is a voting member this year on the Fed’s policy-making committee.) The pickup in the labor market over the winter seemed to suggest that the economy might be ready to fly on its own. But the March jobs report showing only 88,000 new hires may scuttle such speculation for now.

Unemployment is still making America miserable. And the Federal Reserve is still hoping that it can buy the country some happiness.

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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