Sahm Rule

In macroeconomics, the Sahm Rule, or Sahm Rule Recession Indicator, is a heuristic for determining when an economy has entered a recession. It is useful in real-time evaluation of the business cycle and relies on monthly unemployment data from the BLS. It is named eponymously after former Federal Reserve and Council of Economic Advisors economist Claudia Sahm.

Origination

The Sahm Rule originates from a chapter in The Brooking Institute's report on the use of fiscal policy to stabilize the economy during recessions.[1] 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.[2] The trigger suggested indicates an economy beginning a recession and is now known as the Sahm Rule.

Implementation

The Sahm Rule was published by The St. Louis Federal Reserve Bank's FRED system in October 2019.[3][4] 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."[5]

Relying on the change in unemployment from the previous 12 months allows means the natural rate of unemployment is seamlessly integrated. A rule relying on a fixed level of unemployment, on the other hand, cannot take into account drifts caused by changes in demographics, technology, or labor market frictions.[6]

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.[7] Further, unemployment can be more easily understood than complex financial series.[8][9]

Usage

In her original paper, Sahm introduced this metric as a rule to trigger fiscal stimulus in recessionary periods.[2] The metric itself does not provide much use, but Sahm suggests it proves as a stable indicator of recessionary activity that can not be "gamed" or mis-lead by non-recessionary forces.

Reception

The Sahm Rule has received recognition by popular economics news sources.[10][9] Its simplicity and low rate of false positives is an attractive feature.

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.[11] The rule triggered approximately three months into each of the last several recessions, with the beginning of the recession retroactively determined by the NBER.[12] The long-standing inverted yield curve recession indicator is forward-looking but crippled with false positives and uncertain arrival dates.[13]

References
  1. Shambaugh, Heather Boushey, Ryan Nunn, and Jay (2019-05-16). "Recession ready: Fiscal policies to stabilize the American economy". Brookings. Retrieved 2020-12-20.
  2. Sahm, Claudia (2019-05-16). "Direct stimulus payments to individuals". Brookings. Retrieved 2020-12-20.
  3. "FRED Adds Sahm Rule Recession Indicators | St. Louis Fed". web.archive.org. 2019-10-16. Retrieved 2020-12-20.
  4. "FRED Adds Sahm Rule Recession Indicators | St. Louis Fed Economic Research". Retrieved 2020-12-21.
  5. 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.
  6. Sahm, Claudia (2019-05-16). "Direct stimulus payments to individuals". Brookings. p. 77. Retrieved 2020-12-20.
  7. 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.
  8. Schneider, Howard (2019-10-04). "'Sahm Rule' enters Fed lexicon as fast, real-time recession flag". Reuters. Retrieved 2020-12-20.
  9. "The Sahm Rule With The Eponymous Economist : The Indicator from Planet Money". NPR.org. Retrieved 2020-12-21.
  10. "How to spot a recession". The Economist. 2019-06-11. ISSN 0013-0613. Retrieved 2020-12-21.
  11. "Business Cycle Dating". NBER. Retrieved 2020-12-21.
  12. Brown, Randy. "This New Rule To Identify Recessions Could Give Investors An Edge". Forbes. Retrieved 2020-12-21.
  13. "It's Official: The Yield Curve is Triggered. Does a Recession Loom on the Horizon?". today.duke.edu. Retrieved 2020-12-21.
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