Modern macroeconomics textbooks rest upon the assumption of a social welfare function defined on inflation, π, and unemployment, U.2 However, no formal evidence for the existence of such a function has been presented in the literature. 3 Although an optimal policy rule cannot be chosen unless the parameters of the presumed W(π, U) function are known, that has not prevented its use in a large theoretical literature in macroeconomics.This paper has two aims. The first is to show that citizens care about these two variables. We present evidence that inflation and unemployment belong in a well-being function. The second is to calculate the costs of inflation in terms of unemployment. We measure the relative size of the weights attached to these variables in social well-being. Policy implications emerge.Economists have often puzzled over the costs of inflation. Survey evidence presented in Robert Shiller (1996) shows that, when asked how they feel about inflation, individuals report a number of unconventional costs, like exploitation, national prestige and loss of morale. Skeptics wonder. One textbook concludes: "we shall see that standard characterisations of the policy-maker's objective function put more weight on

This paper shows that macroeconomic movements have strong effects on the happiness of nations. First, we find that there are clear microeconomic patterns in the psychological well-being levels of a quarter of a million randomly sampled Europeans and Americans from the 1970's to the 1990's. Happiness equations are monotonically increasing in income, and have a similar structure in different countries. Second, movements in reported well-being are correlated with changes in macroeconomic variables such as Gross Domestic Product. This holds true after controlling for the personal characteristics of respondents, country fixed-effects, year dummies, and country-specific time trends. Third, the paper establishes that recessions create psychic losses that extend beyond the fall in GDP and rise in the number of people unemployed. These losses are large. Fourth, the welfare state appears to be a compensating force: higher unemployment benefits are associated with higher national well-being.

We study the effect of the level of inequality in society on individual well being using a total of 123,668 answers to a survey question about "happiness". We find that individuals have a lower tendency to report themselves happy when inequality is high, even after controlling for individual income, a large set of personal characteristics, and year and country (or, in the case of the US, state) dummies. The effect, however, appears to be stronger in Europe than in the US. In addition we find a striking difference across groups. In Europe, the poor and those on the left of the political spectrum are unhappy about inequality; whereas in the US the happiness of the poor and of those on the left is uncorrelated with inequality. Interestingly, in the US it is the rich who are especially bothered by inequality. We argue that these findings are consistent with the perception (not necessarily the reality) that Americans have of living in a mobile society, where individual effort can move people up and down the income ladder, while Europeans believe that they live in less mobile societies.

We study the effect of the level of inequality in society on individual well being using a total of 123,668 answers to a survey question about "happiness". We find that individuals have a lower tendency to report themselves happy when inequality is high, even after controlling for individual income, a large set of personal characteristics, and year and country (or, in the case of the US, state) dummies. The effect, however, appears to be stronger in Europe than in the US. In addition we find a striking difference across groups. In Europe, the poor and those on the left of the political spectrum are unhappy about inequality; whereas in the US the happiness of the poor and of those on the left is uncorrelated with inequality. Interestingly, in the US it is the rich who are especially bothered by inequality. We argue that these findings are consistent with the perception (not necessarily the reality) that Americans have of living in a mobile society, where individual effort can move people up and down the income ladder, while Europeans believe that they live in less mobile societies.

Economists are trained to infer preferences from observed choices; that is, economists typically watch what people do, rather than listening to what people say. Happiness research departs from this tradition. Instead, happiness researchers have been particularly interested in self-reports of well-being, which may be as simple as an answer to a question with the general form: "Are you very happy, pretty happy, or not too happy?" Hundreds of thousands of individuals have been asked this kind of question, in many countries and over many years, and as reviewed in Frey and Stutzer (2002), researchers have begun to use these data to tackle a variety of questions.Richard Easterlin (1974) was the first economist to make prominent use of happiness data when he reported that despite increases in personal income over time, people were not reporting an increasing level of happiness. This paper begins with a recap of Easterlin's puzzle and the various attempts that have been offered to resolve it by questioning either the interpretation of the happiness surveys or the underlying economic assumption of what economists should include in utility functions. The paper then discusses other examples of research using happiness surveys: to evaluate whether public policies have positive effects on social welfare, like taxes on cigarettes; to determine the welfare costs of inflation and unemployment; and to investigate determinants of political economy like whether the happiness of Europeans is more affected by inequality than the happiness of Americans.