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Sahm rule

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In macroeconomics, the Sahm rule, or Sahm rule recession indicator, is a heuristic measure by the United States' Federal Reserve for determining when an economy has entered a recession.[1] It is useful in real-time evaluation of the business cycle and relies on monthly unemployment data from the Bureau of Labor Statistics (BLS). It is named after economist Claudia Sahm, formerly of the Federal Reserve and Council of Economic Advisors.

Sahm rule 1949-2024

The Sahm rule states:[2]

When the three-month moving average of the national unemployment rate is 0.5 percentage point or more above its low over the prior twelve months, we are in the early months of recession.

Origination

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The Sahm rule originates from a chapter in the Brookings Institution's report on the use of fiscal policy to stabilize the economy during recessions.[3] The chapter, written by Sahm, proposes fiscal policy to automatically send stabilizing payments to citizens to boost economic well-being. Instead of relying on human intuition to determine when such payments should be sent, Sahm outlines a condition to trigger the payments.[4] The trigger suggested indicates an economy beginning a recession and is now known as the Sahm rule. The Sahm rule recession indicator was also featured early in a Goldman Sachs U.S. economic research report by economist William C. Dudley.[5] Edward McKelvey, a senior economist at Goldman Sachs, has also been credited with using the idea very early.[6]

Commentary

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Dr. Sahm cautions:

"The Sahm rule is an empirical regularity. It’s not a proposition; it’s not a law of nature."

And she further explains:

"I created the Sahm rule to send out stimulus checks automatically. The idea was to act fast to make the recession less severe and help families. The star was always the stimulus check, not the indicator that other people named after me.[7]"

Implementation

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The Sahm rule was published by The St. Louis Federal Reserve bank's Federal Reserve Economic Data (FRED) system in October 2019.[8][9] It is retroactively calculated to evaluate performance from past recessions. The recession rule is defined as:

Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months.[10]

Relying on the change in unemployment from the previous 12 months means the natural rate of unemployment is seamlessly integrated. A rule relying on a fixed level of unemployment, in contrast, cannot take into account drifts caused by changes in demographics, technology, or labor market frictions.[11]

The rule only relies on a single data series, national unemployment, which is published monthly by the BLS. This differentiates the index from other recession indicators based on statistical models, which may rely on dozens of inputs.[12] Further, unemployment can be more easily understood than complex financial series.[13][14]

Historical Accuracy

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The Sahm rule is a robust tool that has been very accurate in identifying a downturn in the business cycle and almost always doesn't trigger outside of a recession. The simplicity of the calculation contributes to its reliability. The Sahm rule signals the early stages (onset) of a recession and generated only two false positive recession alerts since the year 1959 (there have been 11 recessions since 1950); in both instances — in 1959 and 1969 — it was just a little untimely, with the recession warning appearing a few months before a slide in the U.S. economy began.[15] In the case of the false positive warning related to the year 1959 it was followed by an actual recession six months later. The Sahm rule typically signals a recession before GDP data makes it clear.[16]

The Sahm rule is designed to indicate that the U.S. economy is in the early months of a recession, rather than forecasting future recessions.[17] While the historical performance and timeliness of the Sahm rule has been very accurate, the reliability of the Sahm rule in today's economy has been questioned by many economists (including Claudia Sahm) due to several distortions and there is reason to believe that the economy might act differently this time around due to unique unusual conditions.[18][19][20][21]This suggests that caution should be exercised when interpreting the Sahm rule in the current unprecedented economic situation. Like all economic indicators, it should be considered alongside other economic data and indicators. However, the Sahm Rule remains a valuable tool for economists and policymakers for early detection of economic downturns.

Table: Historical accuracy of the Sahm rule; Alert coincides with recession: (U.S. unemployment rate, dates when the Sahm rule triggered & actual recession time)[22]
Unemployment rate % Sahm value Time when Sahm > 0.5 Recession starts...
3.50% 0.63 Nov 1953 4 months prior (Jul 1953)
4.50% 0.50 Oct 1957 2 months prior (Aug 1957)
5.80% 0.60 Nov 1959 5 months later (Apr 1960)
4.40% 0.77 Mar 1970 3 months prior (Dec 1969)
5.50% 0.60 Jul 1974 8 months prior (Nov 1973)
6.30% 0.53 Feb 1980 1 month prior (Jan 1980)
8.30% 0.60 Nov 1981 4 months prior (Jul 1981)
5.90% 0.53 Oct 1990 3 months prior (Jul 1990)
4.50% 0.50 Jun 2001 3 months prior (Mar 2001)
4.90% 0.53 Feb 2008 2 months prior (Dec 2007)
14.80% 4.00 Apr 2020 2 months prior (Feb 2020)
4.30% 0.53 Aug 2024 -

In summary, the Sahm rule's reliability lies in its consistent performance throughout various economic climates, particularly in signaling the beginning of a recession with a high degree of accuracy.

Trigger threshold of the Sahm Rule

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The nowadays more commonly used rule triggers a recession signal when the Sahm metric is crossing above 0.5%. Economist William C. Dudley recommended a lower trigger of 0.33%,[23] and economist Edward McKelvey recommended an even lower trigger of 0.3%.[24] Macro-economic writer Mike Shedlock recommends a trigger threshold of 0.4% as the best compromise halfway between McKelvey and Sahm, because as he explains, this already reduces the average lag time of the recession alert to just roughly one month (from a lag time of on average three months when using 0.5%), while not producing too many false positives (but he uses a slightly different rounding in his calculation).

"A trigger of 0.4 percent rounded to a single decimal point does a better job of weeding out false positives [than McKelvey or Dudley] without the lags of Sahm straight up."[24]

Analysis of differing trigger thresholds

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Trigger threshold Lead-lag times[24] False positive warnings[24]
0.3% leads the actual recession start in three cases by two months and in one case by one month produces five (to six) false positive alerts
0.4% leads the actual recession start in two cases by one month produces two false positive alerts
0.5% leads the actual recession start in no case produces one false positive alert

Rounding

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Mike Shedlock explains that he calculates the headline U.S. unemployment rate to three decimal places and then rounds to two. As example for July 2024, the widely used Sahm rule calculates a value of 0.53%, while Shedlock calculates a value of 0.49%.[24]

Reception

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The Sahm rule has received recognition by popular economics news sources.[25][14][26][27]American financial weekly newspaper Barron's describes the metric as a "well-regarded economic rule",[28] American financial news channel CNBC labels the recession indicator as a "fail-safe gauge,"[29] while Investopedia writes that "economists love the indicator for its simplicity and reliability".[30]

Its low rate of false positives are attractive features. Federal Reserve Chair Jerome Powell characterized the Sahm rule as a "statistical regularity" at a press conference in late July 2024.[31]

While the Sahm rule indicates recessions sooner than the formal NBER recession indications, which can take anywhere from half to two years, it is by no means predictive,[32] when using the 3-month simple moving average as filter (because this smoothing of the U.S unemployment data adds a multiple month lag to the calculation). The commonly used version of the Sahm rule with the smoothed 3-month average triggered approximately three months into each of the last NBER recession starts, with the beginning of the recession retroactively officially determined by the NBER.[33]

A lesser-known feature of the Sahm model is that it is particularly useful in assessing recession ends. The standard 3-month smoothed Sahm rule has on average a minimum two month lag to recession ends (while the unsmoothed-Sahm indicator provides for near perfect coincident signalling of business cycle troughs), according to Dwaine Van Vuuren.

See also

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  • Inverted yield curve - Economic indicator predicting recessions, which uses yields on 10-year and three-month Treasury securities as well as the Fed's overnight funds rate.
  • Recession predictors - List of other possible recession predictors, like e.g. Smoothed U.S. Recession Probabilities (RECPROUSM156N), which uses data obtained from a dynamic-factor markov-switching model applied to four monthly coincident variables: the index of industrial production and real manufacturing, non-farm payroll employment, real personal income and trade sales.

References

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  1. ^ "'Sahm Rule' enters Fed lexicon as fast, real-time recession flag". Reuters. 2019-10-04. Retrieved 2023-01-12.
  2. ^ Dr. Sahm, Claudia (2022-12-30). "The Sahm rule: I created a monster". Substack. Retrieved 2024-07-31.
  3. ^ Shambaugh, Heather Boushey, Ryan Nunn, and Jay (2019-05-16). "Recession ready: Fiscal policies to stabilize the American economy". Brookings. Retrieved 2020-12-20.{{cite web}}: CS1 maint: multiple names: authors list (link)
  4. ^ Sahm, Claudia (2019-05-16). "Direct stimulus payments to individuals". Brookings. Retrieved 2020-12-20.
  5. ^ van Vuuren, Dwaine (2024-01-01). "The Sahm Rule Redux". RecessionALERT. Retrieved 2024-07-31.
  6. ^ Shedlock, Mike (2024-08-02). "The McKelvey (Sahm) Unemployment Rate Recession Rule Just Triggered".
  7. ^ Dr. Sahm, Claudia (2022-12-30). "The Sahm rule: I created a monster". Substack. Retrieved 2024-07-31.
  8. ^ "FRED Adds Sahm Rule Recession Indicators | St. Louis Fed". 2019-10-16. Archived from the original on 2019-10-16. Retrieved 2020-12-20.
  9. ^ "FRED Adds Sahm Rule Recession Indicators | St. Louis Fed Economic Research". 2 October 2019. Retrieved 2020-12-21.
  10. ^ Sahm, Claudia, Real-time Sahm Rule Recession Indicator [SAHMREALTIME], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/SAHMREALTIME.December 19, 2020.
  11. ^ Sahm, Claudia (2019-05-16). "Direct stimulus payments to individuals". Brookings. p. 77. Retrieved 2020-12-20.
  12. ^ Berge, Travis J. (2015-05-13). "Predicting Recessions with Leading Indicators: Model Averaging and Selection over the Business Cycle". Journal of Forecasting. 34 (6): 455–471. doi:10.1002/for.2345. ISSN 0277-6693.
  13. ^ Schneider, Howard (2019-10-04). "'Sahm Rule' enters Fed lexicon as fast, real-time recession flag". Reuters. Retrieved 2020-12-20.
  14. ^ a b "The Sahm Rule With The Eponymous Economist : The Indicator from Planet Money". NPR.org. Retrieved 2020-12-21.
  15. ^ "U.S. employers likely added 175,000 jobs in July as labor market cools gradually". AP - The Associated Press, Washington. 2024-08-02. Retrieved 2024-08-02.
  16. ^ "Sahm Rule Recession Indicator". Current Market Valuation (CMV) by Gramalam, LLC. 2024-01-01.
  17. ^ Sahm, Claudia (2024-03-29). "No, you didn't invent the Sahm rule and that's ok, we need more tools!". Substack.
  18. ^ Hetzner, Christiaan (2024-07-29). "Wall Street is worrying about the 'Sahm Rule,' which predicts recessions—but its creator is not, yet". Fortune.
  19. ^ Leonhardt, Megan (2024-08-02). "Today's Jobs Report Triggered a Recession Indicator. But Even Its Creator Doesn't Think There Is a Downturn". Barron's.
  20. ^ Daniel, Will (2024-08-02). "This recession indicator is flashing red, but the 'Sahm Rule' creator says 'this time really could be different'". Fortune.
  21. ^ Jones, Charisse (2024-08-04). "Are we in a recession? The Sahm rule explained". USA Today.
  22. ^ Goldstein, Steve (2024-08-02). "A closely tracked recession indicator, the Sahm rule, has now been triggered. Here's what that means". Marketwatch.
  23. ^ van Vuuren, Dwaine (2024-01-01). "The Sahm Rule Redux". RecessionALERT. Retrieved 2024-07-31.
  24. ^ a b c d e Shedlock, Mike (2024-08-02). "The McKelvey (Sahm) Unemployment Rate Recession Rule Just Triggered".
  25. ^ "How to spot a recession". The Economist. 2019-06-11. ISSN 0013-0613. Retrieved 2020-12-21.
  26. ^ "America's recession indicators are more busted than ever". Axios. 2024-07-23. Retrieved 2024-08-01.
  27. ^ "Keep Sahm and Carry On". The New York Times. 2024-07-30. Retrieved 2024-08-01.
  28. ^ "Every Rule Has Its Exception. That May Be the Case for This Recession Indicator". Barron's. 2024-08-01. Retrieved 2024-08-01.
  29. ^ "Why an indicator that has foretold almost every recession doesn't seem to be working anymore". CNBC. 2024-07-24. Retrieved 2024-08-01.
  30. ^ "This Week's Jobs Report Could Trigger a Usually Reliable Recession Indicator". Investopedia. 2024-07-29. Retrieved 2024-08-01.
  31. ^ "Jobs report could trigger closely watched recession indicator". yahoo! finance. 2024-07-31. Retrieved 2024-08-01.
  32. ^ "Business Cycle Dating". NBER. Retrieved 2020-12-21.
  33. ^ Brown, Randy. "This New Rule To Identify Recessions Could Give Investors An Edge". Forbes. Retrieved 2020-12-21.
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