The Sahm Rule Recession Indicator Definition and How It's Calculated (2024)

What is the Sahm Rule?

The "Sahm Rule" is a recession indicator created and named after Claudia Sahm, a macroeconomist who worked at the Federal Reserve and the White House Council of Economic Advisers. According to the Sahm Rule, the early stages of a recession is signaled when the three-month moving average of the U.S. unemployment rate is half a percentage point or more above the lowest three-month moving average unemployment rate over the previous 12 months.

The Sahm Rule has been widely recognized for its accuracy, simplicity, and ability to quickly reflect the onset of a recession.

Key Takeaways

  • The Sahm Rule is a indicator that looks at signals related to the onset of a recession.
  • According to the rule, the early stages of recession are signaled when the three-month average unemployment rate moves above the lowest three-month moving average unemployment rate over the last 12 months by half a percentage point or more.
  • The rule has become widely recognized as a recession indicator due to its accuracy and simplicity.
  • The Sahm rule was first introduced by macroeconomist Claudia Sahm in 2019 as part of a policy proposal.

How the Sahm Rule Works

The unemployment rate represents the percentage of the overall labor force that is unemployed. The rate tends to rise when the economy is struggling and workers are having difficulty finding jobs, and fall when the economy is strong and workers can more easily find jobs. The Bureau of Labor Statistics (BLS) typically releases the unemployment rate for the previous month on the first Friday of every month. The unemployment rate is one of the main economic indicators used to measure the health of the economy, and the Sahm Ruleinputs the rate into a simple formula to determine whether the U.S. is headed into a recession.

The rule compares the value of the current three-month moving average unemployment rate to the value of the lowest three-month moving average unemployment rate over the last 12 months. If the former is half a percentage point or more above the latter, the Sahm Rule indicates that U.S. is in the early stages of a recession. The Sahm Rule uses the three-month moving average unemployment rate—rather than the current unemployment rate—to prevent overreacting to a single month of data, Sahm said as a guest on The Investopedia Express podcast released in April 2024.

The Sahm Rule simply indicates that the economy is in the early stages of a recession. Since the early 1970s, the indicator has never been triggered outside of a recession, according to Sahm. Historically, when the unemployment rate passes the threshold outlined by the Sahm rule, it continues to increase.

Types of Sahm Rule Indicators

The Federal Reserve Economic Data (FRED) database includes current and real-time Sahm Rule recession indicators.

Current Sahm Rule Recession Indicator

The BLS regularly revises the unemployment rate of previous months based on additional information from its survey that was not initially available. The current Sahm Rule recession indicator iscalculated using the unemployment rate's revised values.

Real-Time Sahm Rule Recession Indicator

Unlike the current Sahm Rule recession indicator, the real-time Sahm Rule recession indicator uses "real-time" data. It iscalculated using just the unemployment rate and recent history of unemployment rates that were available in a given month.

History of the Sahm Rule

Sahm first introduced the indicator that would later be named after her as part of a policy proposal called "Direct Stimulus Payments to Individuals" published by The Hamilton Project, an economic policy initiative that is part of the Brookings Institution. The proposal was also included in The Hamilton Project's book "Recession Ready: Fiscal Policies to Stabilize the American Economy" published in 2019.

In the proposal, Sahm explained that consumer spending tends to slow significantly during recession growth, which can make job losses (and a recession overall) worse. She proposed that to combat that unemployment, the government distribute stimulus payments automatically to families in the face of a recessions—specifically, when the three-month average national employment rate jumps at least half a percentage point relative to its low over the last 12 months.

"Recent research finds that broadly distributed, lump-sum payments to individuals directly boost spending and help stabilize demand, making these types of payments effective responses to recessions," Sahm explained. "The total amount of stimulus would offset about half of the slowdown in consumer spending, totaling about 0.7 percent of GDP." Gross domestic product (GDP) refers to a country's total market value of goods and services within a certain time frame. Fiscal policies like the one Sahm proposed are known as automatic stabilizers.

The indicator became widely recognized, with the Federal Reserve adding it to the FRED database in October 2019.

Limitations of the Sahm Rule

As Sahm has pointed out in her newsletter, the rule is "empirical regularity," not a proposition. She emphasized that this means that the rule can also be broken.

For example, Sahm wrote in an April 2022 newsletter, imagine a scenario in which the unemployment rate increased hovered around 3.5%, up from a low of 3.0%, meeting the criteria for signaling the early stages of a recession based on the Sahm Rule. However, if around that same time, GDP growth held around 2.5%, down from a high of 5.5%, and inflation gradually slid down to 2%, such a combination of circ*mstances probably wouldn't constitute a recession, she explained.

What is the Sahm Rule today?

First introduced in 2019, the Sahm Rule is a recession indicator based on conditions of the labor market. When the three-month average unemployment rate rises above its 12-month low by at least half a percentage point, we are in the early stages of a recession, according to the rule.

Who created the Sahm Rule?

Claudia Sahm, a macroeconomist who worked at the Federal Reserve and the White House Council of Economic Advisers, introduced the indicator as part of a policy proposal. The rule was then named after her.

How Accurate is the Sahm Rule?

The rule has proved to be very accurate with the indicator always triggering in the early stages of a recession and never outside of one since the 1970s.

The Bottom Line

The Sahm Rule refers to an indicator that signals the early stages of a recession. According to the rule, the beginning of a recession is signaled when the three-month moving average unemployment rate is half a percentage point or more higher than the lowest three-month moving average unemployment rate over the last 12 months. Historically, when the unemployment rate has passed this threshold, it has continued to rise.

The Sahm Rule Recession Indicator Definition and How It's Calculated (2024)

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