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People Prefer Inflation To Prospect of Job LossFebruary, 2003 WHETHER IT’S IN DENMARK, GREECE, or the United States, being able to get a job is more important than stable prices to people’s sense of satisfaction and happiness. So says research on the effects of inflation and unemployment by Justin Wolfers, assistant professor of political economy at the Stanford Graduate School of Business. Traditionally, economists have reasoned that the downside of a recession should be largely offset by the upside of a boom. However, as far as personal well-being is concerned, Wolfers shows, the highs of a boom do not compensate for the blues of a bust. happiness destroyed by a recession is much greater than the happiness created by the boom,” he explains; “Recessions really hurt, and governments and their central banks need to be aware of the importance of avoiding them.” Wolfers’ paper, “Is Business Cycle Volatility Costly? Evidence from Surveys of Subjective Well-being,” examines surveys from 16 different European countries from 1973 through 1998 as well as data from the United States and the United Kingdom. By comparing self-reported measures of life satisfaction and happiness in these countries to the rates of inflation and unemployment of the time and place, he is able to show that, percentage point by percentage point, rising joblessness is roughly five times more troubling to people than rising prices. Wolfers presented his results last July to the Council on Foreign Relations/International Finance Conference on “Stabilization Policy: Why and How?” and an article is forthcoming in the journal International Finance. Limiting the magnitude of business cycles has been a concern of macroeconomics, but there has been relatively little work to quantify the effects of economic cycles on people’s sense of well-being and security, says Wolfers, formerly an economist at the Reserve Bank of Australia. “The conventional ‘misery index’ is inflation plus unemployment,” he notes. “Implicit in that index is the view that inflation and unemployment are equally important.” His findings, based on analysis of over half a million individual surveys, show, however, that unemployment outweighs inflation by a ratio of five to one when it comes to a sense of personal well-being. In other words, the unemployment rate rising 1 percentage point causes as much misery as the rate of inflation rising 5 points. Wolfers suggests that the prospect of joblessness causes much more insecurity among both the employed and unemployed than do rising prices. Examining more detailed data on psychological well-being from the United Kingdom, he finds “high unemployment in a region lowers average feelings of usefulness, confidence, and happiness and raises depression and feelings of worthlessness.” Moreover, Wolfers has found, people are also averse to fluctuations in the unemployment rate. Throughout the ordinary business cycle, the unemployment rate rises and falls by around 2 percentage points. If these fluctuations were eliminated, the ensuing feeling of well-being would be equivalent to that gained from permanently lowering the unemployment rate by a quarter of a percentage point, his analysis shows. “Part of this surely reflects human psychology and our tendency to internalize our successes but externalize our failures,” he notes. But there is also some basic economics at play. “Those who are hired during the peak of the boom may be less committed to the job market,” he notes, “while those who are fired during a recession may be highly motivated workers.” Wolfers’ study also looks at the effects of the business cycle on people’s trust. Not surprisingly, recessions lead to a loss of faith in government. But beyond this, people also appear to lose faith in both the corporate and banking sectors. Wolfers suggests that the seeds of the current backlash against corporate America may lie in the recession of 2002. “If you really care about the institution of capitalism,” he says, “you would think recessions are a really bad thing.” In terms of economic policy, Wolfers suggests that keeping inflation rates at rock bottom may not be as important as stabilizing unemployment rates—even though the effects of inflation are often permanent and unemployment transitory. “The policy conclusion is that Alan Greenspan should keep an eye on both inflation and unemployment,” he says. “Keep unemployment stable—if inflation’s a little more unstable, the cost may be worth it.” —MARGARET YOUNG Is Business Cycle Volatility Costly? Evidence from Surveys of Subjective Well-being, by Justin Wolfers, GSB Research Paper #1751, July 2002 and forthcoming in International Finance |
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People
Prefer Inflation to Prospect of Job Loss
