Misery index gives cause for hope

There is an unmistakable inverse correlation between emiserating factors like unemployment, wages and house prices and consumer confidence, but new analysis suggests things may be looking up, says James Sproule

The cost-of-living crisis may be difficult to define or quantify, but it is easy enough to feel –  and misery has been felt not just in the UK, but globally.  A combination of factors – including pandemic disruption, the Ukraine war, and broader security questions – have raised food and energy prices. This in turn has raised inflation to levels not seen since the 1970’s and necessitated interest rates now move off the rock-bottom levels where they had rested for fifteen years.  It may be a return to normality, but it is also a lot of change.

For economists, the challenge is to forecast what happens next. It is fair to say things have been fairly miserable, which is why we, as an international bank, created a ‘misery index’ as a way to look ahead and found some – tentative – good news.

The concept of a misery index was first proposed in the 1960s by US economist Arthur Okun. He put together two specific measures –  inflation and unemployment – to gauge, economically, how people felt. Okun assumed, rightly, that high inflation plus high unemployment equalled misery. The index came to the fore in the 1980 Presidential election. Ronald Reagan asked people if they felt better off than they had four years previously; the answer was clearly no. Fast forward to today; we wanted to analyse not just how miserable the average global household was, but also whether people were likely to get happier soon. So we broadened the factors we considered that might make people miserable,  measuring inflation, unemployment, interest rates, the stock market, house prices, and wages. Focusing on markets we know well, we compared the United Kingdom, the United States, the Eurozone, Sweden, Norway and Finland.

Benchmarking misery metrics

While there are similarities, these countries are obviously not the same. Business cycles vary, as do some main drivers of household finances.  For example, there are more fixed rate mortgages in the UK, so interest-rate rises have less immediate impact than they do in Sweden for instance. Equally, the level of employment is often related to cultural differences that are reflected in employment legislation. But we did find a common trend for each of the six variables – and it held through episodes ranging from the global financial crisis to the pandemic, as well as in the less-volatile periods in-between. So in order to have a point of comparison, we benchmarked our misery metrics against two others: consumption and consumer confidence. This turned up something rather remarkable.

 We found economic misery tracks both consumption and confidence almost exactly. It didn’t matter whether we measured against the financial crisis, the eurozone debt crisis, long periods of low interest rates, the pandemic or the challenges of inflation; the results were the same. The inverse correlation between misery and confidence is unmistakable in every country we measured.  

So what does this mean? The good news is our index shows misery is reducing and confidence recovering, which should mean consumption returns to normal levels. Households, once again, have purchasing power and are able to support demand. Moreover, lower inflation is allowing lower interest rates which benefit household finances .

But this is a global picture; how does it relate to the UK? Here we have a challenge of persistently-sticky services inflation, driven by earnings growth. The question remains: are recent public-sector pay settlements going to cool off, or spill over into the broader economy? At least lower energy prices have allowed the Bank of England to make its first rate cut, with more in the pipeline.  

There is more good news; our recent election has delivered a stable government – vital for markets. And it is important to remember the UK is an open economy, thus as other countries start to recover, so will we. To take just one example, it’s a cliche that ‘when America sneezes, the world catches a cold’, but America seems to have reached for the Lemsip, and that should cheer us all.

Ultimately, our misery index suggests the world is approaching a ‘confidence soft landing’. For all that the UK is still experiencing some volatility around confidence, we should – tentatively – see this start to show at all levels in the UK economy, right down to household finances. And perhaps we can start to hope we will all feel a bit less miserable, soon.

James Sproule is chief economist, UK at Handelsbanken