Monday, September 21, 2009

Distress Index

The Foundation for Economic Education has asked me to put together a Distress Index. So I quickly threw together five variables to create the index.

There is more detail at the FEE webpage (and a better picture too).

The idea was to keep the index simple, so that no more than a handful of statistics are used, and it was also important that those statistics be relatively uncontroversial. So we relied solely on numbers provided by the Federal Government.

Included Statistics:

Unemployment: Clearly, no “misery” index would be very relevant without considering unemployment. This is pretty self evident.

Consumer Price Index: Like the original “misery” index, we included inflation, even though we are actually in a deflationary period at the moment.

Gross Domestic Product: GDP is the market value of all final goods and services in a particular geographic area over a period of time. It is the most widely recognized measure of the "health" of economy.

Total Capacity Utilization (TCU): This is a measure of the utilization of the all available capital goods. We use the inverse of this number, since higher utilization is generally a good thing. So for instance, if TCU is at 70 percent, we would add 30 percent to our index as a measure of the idle capacity.

Household Financial Obligations as a percent of Disposable Personal Income (HFO/DPI): This measure is intended to gauge the ability of individuals to participate in the consumer economy.

It is important to emphasize that no statistic will ever fully articulate what is happening in the real economy. The real economy is made up of living, breathing, planning, acting individuals. Statistics are simply an abstraction and, as such, imperfect. Nevertheless, we feel this index has substantial value for two reasons.

First, it gives us a tool to help interpret what the media and government are telling us about the economy. Second, we hope it will give voice to the taxpayer and the frustrating conditions he or she is enduring these days. We hope the index will keep pressure on policy makers and opinion leaders to make decisions that improve the economy rather than distressing it further.

After a cursory historical analysis on the index, we can see that the results were pretty impressive. The chart below shows the Distress Index since 1967 with economic recession periods highlighted. There seems to be at least a superficial correlation between the index breaking 45.0 and the economy falling into recession. (Note we have not tested the strength of this correlation). In most cases the index appears to lead the recession’s beginning and end, which would seem to indicate that the index is actually useful in telling us where we are headed, not just where we’ve been.


Unemployment: 9.7%

CPI: -1.5%

Real GDP: 3.897% (as a % change y-t-y × -1)

TCU: 30.4% (100% - TCU = an Idleness Index)

HFO/DPI: 18.5%

Please feel free to comment and improve this index.


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