The Sahm Rule: What it is and Why it Matters

• What is the Sahm Rule
• Understanding the Sahm Rule’s Key Indicators
• How Does it Work?
• Calculating Sahm’s Rule
• Conclusion

What is the Sahm Rule?
The Sahm Rule, created by economist Claudia Sahm in early 2019, is a quick reference tool for identifying early signs of a possible recession. It acts as an "early diagnosis" to help policymakers anticipate economic downturns. Officially, the National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity lasting more than a few months. However, the NBER’s process for declaring a recession can take time.

Understanding the Sahm Rule’s Key Indicators
The Sahm Rule is a straightforward tool to help spot early signs of a recession. It’s designed to alert policymakers when the economy might be slowing down, allowing them to respond more quickly. The rule is especially useful because it relies on unemployment data, which is updated more frequently and promptly than many other economic indicators.

How Does it Work?
The Sahm Rule detects signs of a recession by monitoring changes in the unemployment rate. Here’s how it works: if the average unemployment rate over the past three months rises by 0.5% or more from its lowest point in the previous year, it signals a potential recession. This approach helps avoid false alarms from short-term unemployment fluctuations that don’t indicate a prolonged downturn.

To keep these signals timely, the Sahm Rule relies on the latest unemployment data, which is released monthly by the Bureau of Labor Statistics (BLS). This real-time data keeps the rule up-to-date, allowing policymakers to respond quickly if the economy shows signs of trouble.

Calculating Sahm’s Rule:

Figure 1: U.S. Unemployment Rate Figures, Sep 1, 2023 – Nov 1, 2024, forex factory

Step-by-Step Calculation for November 1, 2024 (Figure 1):

1. Identify the Lowest Unemployment Rate in the Past 12 Months:
   • Looking at the data from November 1, 2023, to November 1, 2024, the lowest unemployment rate recorded was 3.7%, which occurred in January and February 2024.
2. Calculate the 0.5% Increase from the Lowest Rate:
   • According to the Sahm Rule, we set the recession signal threshold by adding 0.5% to the lowest unemployment rate, which in this case is 3.7%: 3.7%+0.5%=4.2% 
   • This means if the three-month average unemployment rate rises to or above 4.2%, it signals a potential recession.
3. Calculate the Three-Month Moving Average for November 1, 2024:
   • To calculate the three-month moving average for November 1, 2024, we take the actual unemployment rates from September 6, October 4, and November 1, 2024.
     • September 6: 4.2%
     • October 4: 4.1%
     • November 1: 4.1%

Three-month average= 4.2 + 4.1 + 4.1 / 3 = 4.13%

1. Compare the Result with the Threshold:
   • The three-month moving average for November 1, 2024, is 4.13%, which is below the threshold of 4.2%.

End Result Analysis

As of November 1, 2024, the Sahm Rule has not yet been triggered because the three-month moving average (4.13%) remains slightly below the 4.2% threshold. This indicates that, while unemployment has risen, it has not yet reached the level that would signal a recession based on the Sahm Rule.

Conclusion

The Sahm Rule has attracted significant attention among economists, particularly during periods of economic instability. Recent reports indicate that it has been triggered, signaling possible economic weakness and raising recession concerns. However, some economists caution that traditional recession indicators, like the Sahm Rule, may be less reliable in a post-pandemic economy marked by unique challenges such as supply chain disruptions and high inflation. It's also important to remember that no indicator is 100% accurate, and economic signals should be interpreted with a degree of caution.