Comment: Misery index says good year for economy

Bill Jamieson. Picture: Ian Rutherford
Bill Jamieson. Picture: Ian Rutherford
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HERE is news that should cheer us up. The UK economy is set to have its happiest year in over half a century.

We know this from a handy little device in the economists’ toolbox called the Misery Index. It is the sum of the two most depressing features of modern economies: the inflation rate and the unemployment rate. Plot these two together and we have a rough and ready measure of the health of our economy.

On this score, we should be very happy by now. Cheaper fuel pushed the rate of UK inflation to a 12-year low in November. The Consumer Price Index dropped to one per cent last month, from 1.3 per cent in October, while the Retail Prices Index (RPI) inflation also fell to a five-year low of two per cent.

The UK unemployment rate is down to six per cent, its lowest level for six years, while in Scotland it is down to 5.6 per cent.

As for 2015, we are on course to be positively ecstatic. The CPI inflation rate for December, due out this week, looks set to fall below one per cent. And unemployment is likely to continue falling, albeit at a slower pace than in 2014.

This should give us the lowest reading on the Misery Index for decades – back to levels not seen since the late 1960s and early 1970s before the Opec oil price hikes and the onset of double-digit inflation.

The Misery Index – often seen as the alter ego of the Feel Good Factor – was first formulated by the economist Arthur Okun. Using long-run statistical data, charts from Oxford Economics show that the UK economy was at its most miserable during the high inflation, low growth period of the mid-1970s and early 1980s.

The Misery reading saw a steady decline through the Non-Inflationary Constant Expansion (NICE) period of the 1990s to the mid-2000s. The onset of the financial crisis and subsequent recession saw an upward spike.

But since 2011, the index has been steadily falling as inflation and unemployment have steadily declined. The outlook for this year is that CPI inflation should average only 0.4 per cent. The Oxford Economics analysis makes a useful and much overlooked distinction between “good” disinflation,driven by falling oil and petrol prices, and “bad” disinflation resulting from depressed demand and high unemployment. Much of the commentary in recent days about the onset of deflation has assumed that it is always and everywhere a uniform phenomenon – no different from Japan – and has tended to overlook the different contexts and dynamics behind the disinflation experience.

But the circumstances in the UK and Europe today are quite different to those that have bedevilled Japan.

What we know is that on current trends, inflation should continue to be very subdued this year. As for unemployment, Oxford Economics forecasts that robust GDP growth should push the UK unemployment rate down to 5.2 per cent by the end of 2015.

The two combined should make 2015 “a thoroughly un-miserable year”.

As for business, the latest British Chambers of Commerce (BCC) quarterly survey, the largest in the UK, suggests the economy will continue to grow strongly. Key readings for activity, orders and investment intentions in manufacturing and services have all strengthened and the overall average reading for new orders is the sixth-highest of any quarter in the past 25 years while that for domestic orders is the second-highest. Among both manufacturers and service sector firms, the readings for job growth and the share of firms that tried to hire staff are at record highs. And the overall average reading for firms’ investment intentions is the second-highest ever.

Using long-run measures of inflation and employment derived from economic historians back to the mid-19th century, “2015”, say the economists, “should see the economy enjoy its happiest year since 1960 and one of the least miserable peacetime years in the last century”.

Such a remarkable reading should surely lift our spirits and certainly give cheer to Prime Minister David Cameron with the election just four months away. But it does not at all feel like “the end of misery” for most of us. And opinion poll readings suggest the Conservatives are struggling to achieve a rating higher than Labour.

Correlation between movements in the Misery Index and opinion poll scores for the governing party is by no means assured. A halving of the misery index from 1992 to 1997 did not stop the erosion in support for the John Major government. And the low level of the Misery Index between 1997 and 2005 did not stop Labour’s lead in the opinion polls from ebbing away.

Other factors, of course, have an influence: the level of business confidence and investment, movements in house prices – higher values make owner occupiers feel more confident and secure and enhance their ability to borrow on the strength of rising house equity. Perceptions of inequality – that the already wealthy are enjoying larger gains in income and asset prices than the rest of us adds considerably to voter dissatisfaction.

Arguably the biggest determinant of the Misery Index today is the flatness of average real earnings: household incomes have until recently lagged inflation, bringing a squeeze on budgets and consumer spending. And for the moment there is little expectation among voters of any significant increase in real living standards.

This may change before long as the combined effects of real earnings growth, falling petrol prices and continuing falls in inflation start to make an impact on voters’ sense of well-being. This is certainly what the UK government is desperately hoping will kick in before the first week in May.

But it is currently difficult for 
this to make headway against concerns over public deficit and debt and the repeated warnings of further cuts in public expenditure that lie ahead. Whatever the Misery Index might tell us, the government, it seems, would like us to feel happy and apprehensive simultaneously.