There are few institutions examined more scientifically or mathematically than the U.S. economy. After all, in-depth understanding of economic conditions mean billions of dollars to the right people and policy makers. Unfortunately, a nation’s economy is a complex machine composed of an almost infinite number of moving parts. Economists seek to study and understand the economy in many ways, often by simplifying things with numbers and formulas. One of my favorite names for an economic statistic is the Misery Index.
How to Calculate Misery Index
The original Misery Index was surprisingly simple. You calculate the Misery Index by adding the unemployment rate to the inflation rate. The idea is that both unemployment and inflation are negative factors acting against a positive economy. By combining them, you could get some idea of how much of a headwind the economy is facing. Under this methodology, things would be worst during a time where unemployment was high and inflation was also high.
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Ironically, the Misery Index can peak right before a strong recovery. Consider a situation where there has been a recession or depression. Unemployment rises as companies lay off workers to reduce costs and respond to weaker demand. In this scenario, people often start spending less money, even if they still have their jobs out of the fear that they may lose them. This is one reason unemployment numbers are so important to Wall Street. (This fear of spending due to economic uncertainty is measured by other economic statistics, including the Confidence Index.)
When the economy moves from contraction to expansion, consumer or business spending pick up and companies may respond to the increased demand by raising prices. This triggers a higher inflation number.
While the economy improves and prices rise, companies are slower to re-hire. After all, laying people off is a costly endeavor in money (severance,unemployment, potential lawsuits), reputation, and morale. At this point, the unemployment number will be high, while the inflation number rises, resulting in the peak Misery Index reading.If the economy continues to recover, then the Misery Index will fall only when the unemployment rate drops faster than the inflation rate rises.
Misery Index and Investing
The Misery Index is considered a coincident indicator, meaning basically that it tells you what is happening now. Looking out your window to predict the weather would be a coincident indicator. In other words, while this would be a good way to see if you need an umbrella when you walk out the door, it’s a terrible way to know if you need to pack a sweater for later in the week.
Similarly, the Misery Index isn’t, by itself, much of a way to predict movements in the overall economy or choose investments. However, the Misery Index is a good indicator to watch for overall trends and movements and to confirm hypothesis derived from other economic numbers and reports. A declining Misery Index, for example, is a sign of a healthy economy, while a rising one may be a confirmation that things really are getting worse.
As always, a single number is worthless as a way to predict either the markets or the economy. However, the Misery Index can be a useful tool when taking a look at the overall situation.