How To Measure Poverty? – The Misery Index
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It seems that living in a developed or developing country will go through poverty and poverty is something abstract but in every country there are groups of people who live in poverty. The cause of poverty is money.
Money may not make you happy, but there is often a correlation between economic opportunity and personal well-being. After all, you probably won't be very happy if you can't afford basic necessities, find a job, or get a loan.
To check how many cases there are that cannot afford to meet basic needs, the Misery Index was created.
What is the Misery Index and what is it used for?
The Misery index is an economic indicator that measures how well the average person is doing financially. It uses a few simple inputs to create an easy-to-understand and repeatable measure of a nation's poverty level.
The classic Misery Index consists of two components: inflation and the unemployment rate. In the simplest sense, inflation is a loss of purchasing power by households as a result of an increase in consumer prices. In turn, the unemployment rate affects the household budget in two ways. First, some household members cannot find work, which reduces family income. In addition, the high unemployment rate lowers the wage pressure, so that nominal wages do not grow quickly. Due to the fact that the index is the sum of the inflation rate and the unemployment rate, the high value of the Misery Index may be due to:
- High unemployment rate and high inflation,
- High inflation and low unemployment rate,
- High unemployment and low inflation.
As a rule, economists consider the economy to be in full employment when the unemployment rate is 4-5%. In turn, the inflation target for many countries varies between 2-3%. As a result, the "optimal" poverty rate should be between 6%-8%.
Factors included in the Misery Index
A closer look at each of the misery index factors can be important in understanding how indexes work. Focusing on Hanke's Annual Misery Index (HAMI), which we'll discuss later, these factors are:
- Annual unemployment rates. Unemployment measures the percentage of people who are actively looking for a job but cannot find one.
- Annual inflation rates. Inflation is the rising cost of goods and services. When prices go up, you need more money to buy the same thing, so inflation can lead to unhappiness.
- Interest rates on bank loans. The rates that banks pay for short-term loans, which may affect the rates consumers pay for loans and lines of credit.
- Gross domestic product change. Real gross domestic product (GDP) measures the change in a country's economic output after accounting for inflation or deflation.
A higher number is worse because it indicates that the country is more unhappy.
How to Calculate the Misery Index
To calculate HAMI, add inflation, unemployment and interest rates. Then subtract GDP per capita to determine the current poverty rate.
HAMI = [Unemployment + Inflation + Bank Credit Rate] − Real GDP growth
Misery Index - Limitations
The simplicity of the aforementioned index is also its disadvantage, because it leads to the fact that its indications are not as precise as the more "sublime" variants of indicators measuring the "health" of the economy. Here are some examples of the misery index's disadvantages:
- One of the disadvantages of the index is its "blindness". An example is the unemployment rate, which does not measure the level of the unemployed in the entire population, but only in the group of people actively seeking employment. For this reason, people who have lost their jobs and stopped looking for them are not considered unemployed.
- Another problem is the interpretation of the level of inflation. Periods of very low inflation, or even deflation, are "good" according to the poverty index, but they may indicate stagnation rather than health. A good example is Japan, which has had problems with raising the level of inflation for many years. However, the effects of government actions in Japan are poor.
- The third disadvantage is also that they treat the increase in inflation and the unemployment rate in the same way. However, a 3 percentage point increase in the unemployment rate has a greater effect on "population poverty" than a 3 percentage point increase in the inflation rate.
The Story of the Misery Index
The misery index was created by economist Arthur Okun, who used the simple sum of the inflation rate and the unemployment rate. He decided that such a composition of the indicator would make it possible to examine the "health" of the economy. The lower the index, the better the condition of the national economy.
Arthur Okun was from 1968 to 1969 chairman of the US Council of Economic Advisers (CEA) during the presidency of Lyndon Johnson. He was also a professor at Yale University. In addition to the poverty index, he also formulated the relationship between the unemployment rate and Gross Domestic Product (GDP). It was named Okun's law in honor of its discoverer. It says that an increase in the unemployment rate above the "natural level" has a negative impact on the level of GDP.
The popularity of the misery index dates back to the 1970s, after President Nixon suspended the US dollar's convertibility to gold. This was one of the reasons why the US economy struggled with high unemployment and high inflation over the next few years.
Source: investopedia.com
