How reliable is the Sahm rule as a recession indicator?
How reliable is the Sahm rule as a recession indicator?
When the monthly jobs report from the Labor Department was released in August at 8:30 a.m., it packed a punch. Something called the Sahm Rule had been triggered — it was like an economic fire alarm was going off.
And at 8:31 a.m., economists all over the country started getting frantic phone calls from reporters and analysts, all with the same question: Is the recession here?
“I was live on the radio, and they read the numbers out loud. I said, ‘OK, so the Sahm Rule says we would be in a recession, but Sahm says we’re not,’” said Claudia Sahm, the economist who came up with the eponymous recession indicator back in 2019.
She was on Bloomberg radio when the jobs report came out and immediately said she didn’t think her rule was right this time.
Sahm discovered the rule when she was studying previous recessions as part of a project to help policymakers prepare for the next one. She wanted to create a mechanism that would allow policymakers to know a recession was happening as soon as possible, so they could get aid to people before they were in deep crisis.
After a decade at the Federal Reserve, Sahm knew unemployment patterns were the place to look. And she found when she looked back through decades of data, that whenever the unemployment rate rose by half a percentage point within 12 months, it meant the country was in the beginning of a recession.
“The unemployment rate has historically done a pretty good job of summarizing what’s going on in the economy,” she explained. Pretty good might be understating it: since 1970, the Sahm rule has accurately signaled every recession.
So why is Sahm, the economist, discounting Sahm, the rule, now?
The unemployment rate, Sahm explained, has an Achilles’ heel: It doesn’t only go up when people lose their jobs, it can also go up when the number of people looking for jobs goes up.
“When you have people enter the workforce, it can take longer to find a job, even in the best of times,” she said. “That will push up the unemployment rate.”
It’s kind of like a high school dance: You have the couples on the dance floor, and then you have some single people wandering around looking for partners. They represent the unemployed people.
But then, a really great song comes on, and suddenly a bunch of new people edge out onto the dance floor: the wallflowers! They were always at the dance, they just weren’t out on the dance floor — they were hanging back.
In the job market, these are the people who don’t have a job, but haven’t been looking for a job. They weren’t out on the dance floor, but now they’ve arrived and they’re actively looking for a job. That can push up the unemployment rate.
Sahm said this distortion in the data is largely because of COVID-19. Millions of people dropped out of the workforce early in the pandemic, and many didn’t come back for years. Some were scared of getting sick; some had child care duties; some had a little extra money and wanted to take a pause. Now, a lot of them are jumping back in.
At the same time, immigration dropped way down, and it’s been ticking up in recent years. All of that is pushing up the unemployment rate.
“So, you’ve got workers who’ve come in and are looking, and the jobs are catching up,” Sahm said.
At first, when our wallflowers shimmy onto the dance floor, it looks like there are more people without partners: Everybody’s breaking up! This dance is a bust!
But really, there are just more people on the dance floor. It might take them a minute to find a partner, but when they do, the dance gets bigger and better.
“As the jobs catch up, it’s a good sign,” Sahm said. “You’ve got more people, right? So the economy is growing.”
More people looking for jobs means more people getting jobs, and getting paychecks they will spend on groceries, haircuts and cars. Which means more business for those grocery stores, hair salons and car dealerships. And voila: the whole dance grows.
But before we all put on our dancing shoes, Sahm said her rule is still a warning. Just because the Sahm rule isn’t telling us what we thought it was doesn’t mean it isn’t telling us anything.
“The Sahm rule right now is overstating the weakness in the economy,” Sahm said. “But it is picking up on weakness in the economy. It’s telling us something bigger than itself.”
Sahm suspects it’s telling us that the job market is softening. After all, hiring is at its lowest rate since 2020 and job openings are at a three-year low. If those numbers don’t pick up soon, it could mean a lot of wallflowers end up dancing on their own for quite a while.
Stories You Might Like
There’s a lot happening in the world. Through it all, Marketplace is here for you.
You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible.
Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.
