Claudia Sahm, a former Fed economist, popularised a real-time recession test which she called the Sahm rule. According to Sahm, a recession is likely to start when the three-month average of the unemployment rate rises by a minimum of 0.5% relative to its low during the previous 12 months. The idea of using the three-month average is to smooth out some of the random monthly variation in unemployment, while using the minimum takes into account structural changes over time in the natural rate of unemployment. It is a relatively simple measure, and so far has proved to be remarkably accurate at identifying US recessions ― it has correctly called them all since 1960, with zero false positives.
Unemployment in the US has risen over the past few months, and is approaching the Sahm rule’s recession threshold. However, like so many other indicators during the pandemic era, this time the Sahm rule could be about to give a false signal. The first two years of the pandemic saw severe labour shortages, but since then workers have been coming back at a somewhat faster pace than new jobs have been created. This is good news for the rebalancing of the labour market, even if it shows up initially in a higher unemployment rate. Therefore, unemployment may climb higher for some time, as the economy re-adjusts to balance the supply of and demand for labour, which would trigger the rule — but not necessarily a recession.
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