If a president presides over a large increase in the Misery Index it is difficult to get re-elected. The largest increases were under Nixon, Carter, Obama, and Eisenhower, while Truman, Reagan, Ford, Clinton had the best experiences – less misery. Carter had the highest rate of about 21% in 1980. The lowest rate was in 1965 – 6.1% — by President Johnson. Obama’s 2010 figure is 11.29.

Below you will find a Misery Index for the United States from 1960 to 2010. This comes from :  http://www.miseryindex.us/customindexbyyear.asp

Note: It is published in red and blue. If you cannot see color, the first part of the bar on the left is the unemployment rate. The second part of the bar on the right is the inflation rate.

ss

This is fun history for us, but more importantly it points out that inflation and unemployment are very important indicators of a country’s economic wellbeing. In this note we begin by defining some terms with which to understand inflation better. We also look into why inflation is or is not a problem.  We then move on to key terms relevant to understanding employment and unemployment. The final section examines the relationship between inflation and unemployment – in both the short- and long-run. We discuss how macroeconomic policies can and should be used to remediate rising inflation and/or unemployment.  A Phillips curve has become a standard way to discuss inflation and unemployment in the short- and long-run. Terms like “policy tradeoffs” and “shifting Phillips Curves” have become common ways to identify specific macroeconomic issues. We will define the Phillips curve and explain how it connects to our previous discussions of AD and AS.

The following two representations of the U.S. Phillips Curve were taken from: http://www.tutor2u.net/economics/content/topics/inflation/philips_curve.htm

Notice the focus on trade-offs and shifts in describing various time periods. We will elaborate on these kinds of changes more below. For now, just notice that there are time periods when the country seems to be moving up or down along a given curve and then other time periods when the whole curve seems to shift out (from the 70s to the 80s) or to shift in (from the 80s to the 90s).

Screen Shot 2016-04-24 at 11.17.02 AM Screen Shot 2016-04-24 at 11.17.09 AMMotivation

While much of the time of planners is spent thinking about real GDP growth, it is very worthwhile for them to also think about future inflation and unemployment as well. Expectations about future inflation can impact one’s forecasts of various other key indicators. For example, if you believe that inflation is going to creep up over the next five years, then you also believe that market interest rates will follow. While wages are sometimes slow to catch-up with inflation, given enough time they usually will. If you are projecting that U.S. inflation is going to rise relative to inflation of its key trading partners, then this could impact exports and imports as well as the future exchange rate. Clearly, the future expected inflation rate will never be known with perfect certainty, but since it affects so many other important variables, most planners try to understand more about its characteristics and causes.

We also want to know more about employment and unemployment. As we have learned in the recovery time periods after the recessions in the early 1990s and in 2001, employment does not automatically snap back when the economy begins to grow faster. That is, employment and unemployment can have their own lives somewhat apart from the overall growth of the economy. Thinking more about future unemployment helps a company think better about the ease and cost of their new plans. Those who correctly anticipated the labor shortages of the late 1990s, for example, might have done better than those who were surprised by it and couldn’t find appropriate labor for their output plans. In 2004 companies had an easier time of finding good employees – but those that knew that employment was going to revive slowly may have been able to secure necessary workers at a lower cost than those who thought the labor pool was going to tighten more.

It is clear that knowing a little more about inflation and unemployment adds to a planner’s general and specific knowledge of changes in the macroeconomic environment. But knowing more about these two economic indicators may have an even more important benefit – that has to do with macroeconomic policy. Sometimes more than the changes in inflation and unemployment themselves, changes in the policies designed to counteract them contribute to the macro situation. In 1979 when President Carter and the Fed joined together to try to whip stagflation, they threw the U.S. economy into a deep recession. A major coordinated policy attack struck again in the aftermath of a recession and the 9/11 tragedy, when President W. Bush and Alan Greenspan purposely and aggressively stoked up the fires of aggregate demand. To what extent did business planners anticipate these policy changes? To what extent were they a total surprise? Those who knew more about the political-economy of inflation and unemployment changes might have been somewhat more prepared to deal with the changes in the misery index as well as changes in AD and AS policy.

The above makes one think that inflation and unemployment rates always move in tandem – together in the same direction. But that isn’t true. In fact, the more common case is probably the opposite – in which a decline in the unemployment rate is associated with a rise in inflation during an expansionary period or a rise in unemployment goes hand-in-hand with falling inflation during an AD-induced recession.  This raises the unhappy situation for forecasters and planners to understand why at times these two variables will move in the same way (shifts of the Phillips Curve) while at other times they go in opposite directions (trade-offs along a given Phillips Curve).

It also raises the additional policy question – which one is Macro Public Enemy #1 – inflation or unemployment? Answering that question can help planners make better decisions since it helps them know whether macro policies are going to be aimed at taming inflation or rescuing the unemployed. The year 2004 was clearly a time when planners were trying to come to conclusions about this. Was 2004 a year in which the strong economic growth was leading to much higher inflation – or was it a year in which economic growth slowed and was headed for recessionary conditions? Planners who guessed correctly were probably better prepared for the economy in 2005.

Screen Shot 2016-04-24 at 11.17.40 AM