Identifying a Recession in Real Time

The stock market is in a turmoil, on Monday falling farther and faster than at any time since 2008, before rising again at today’s open, in a spate of volatility over the last couple of weeks that has been variously attributed to the uncertainty surrounding the spread of Covid 19, tumbling oil prices, disrupted international supply chains, and other things. But is this just market volatility, or is a recession looming? After more than ten years of steady growth, might the longest peacetime economic expansion of the U.S. economy be at an end?

No one knows. And anyone who says they know is lying. One of the big problems that has always faced economic policy makers has been that traditional metrics are so backward looking that it takes several months, sometimes even a full year, to decide whether a genuine economic “recession” (defined as a fall in GDP for two consecutive quarters) has actually begun. Economists only labeled the Great Recession of 2008 as an actual, official recession in December 2008, for instance, twelve months after quarterly GDP first began falling in December 2007.  

If we could somehow tell, in real time, when a recession is actually beginning, then we could take a variety of immediate steps to mitigate and shorten such a downturn. We could, for instance, provide automatic stimulus payments of some type to consumers, both to offset the hardship and to support continued consumer spending. We could temporarily increase unemployment benefits. We could issue tax credits against home mortgage interest. Or we could take any number of other temporary steps to minimize the economic damage, not just to consumers, but to businesses.

Well, now we can tell. Using a new metric called the “Sahm Rule,” named after Claudia Sahm, the Federal Reserve economist and consumer section chief who discovered it, we should be able to determine, more or less in real time, when the next recession begins. In looking backward at all recessions in the last sixty years, the Sahm Rule would have called every one of them correctly, with no false positives. And it would have done this within weeks of each recession’s beginning, not the many months required before.

The Sahm Rule is actually very simple, based on changes in the monthly unemployment rate, which is issued at the beginning of every month, with respect to the last month’s rate. Specifically, the Sahm Rule says that a recession has begun if and when: 

The increase in the three-month moving average of the national unemployment rate rises by 0.5% or more, relative to its low during the previous 12 months.

Sahm only proposed her rule in an economic paper last year, but its predictive power, in retrospect, would have been so good that the Fed and other economic bodies now monitor the Sahm Rule each month, carefully.

Below is a graph of the Sahm Rule taken from St. Louis Federal Reserve Bank’s website: 

If and when the next recession starts, at least we can expect it to be identified almost immediately. Watch this space!