America may soon be in recession, according to a well-known rule

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For financial markets the Holy Grail is an excellent auspicious sign – a gauge that is both simple to check and consistently accurate in predicting the future. In reality, predictable perfection is unattainable. It is often difficult to understand what is happening in the present, let alone the future. A real-time signal would therefore be a perfect cup of knowledge, if not quite the Holy Grail, for investors and analysts to drink. Recently they have turned their attention to one impressive candidate: Sahm’s rule.

Developed by Claudia Sahm, a former economist at the Federal Reserve, in 2019, the rule would have been able to identify every recession since 1960 at an early stage, without fail. This is not a good move because the agency that officially declares whether the American economy is in recession sometimes needs a full year of data. Sahm’s rule usually only takes a few months.

Photo: The Economist

Like all good rules, it is parsimonious. If the unemployment rate rises half a percentage point from its level in the past 12 months, the economy is said to be in recession. To smooth out the figures, which jump around, both the current unemployment rate and the trough are calculated as a three-month moving average. At the moment the Sahm indicator is at 0.33 percentage points. It wouldn’t take much to reach the half point mark. If the unemployment rate, which hit 3.9% in October, rises to 4.0% this month and 4.1% next month, the economy, according to Sahm’s rule, would be in recession.

What about in reality? As Ms. Sahm herself is quick to point out, her rule describes an empirical regularity, not an immutable law. Moreover, the post-pandemic economy may have been fostering the very kind of conditions that break this normality. During a recession companies fire workers, and the layoffs usually go well past the halfway point line of Sahm’s rule.

This time, however, it seems that the increase in the unemployment rate has been driven less by a decrease in the demand for workers and more by an increase in their supply. America’s labor force, including both people in work and looking for jobs, has expanded by nearly 3m, or 1.7%, since the end of last year. In the same period the number of jobs has increased by 2m, or 1.2%. “If workers come back and the jobs haven’t caught up with them, the unemployment rate can move up,” said Ms. Sahm. “But then as the jobs go up, the unemployment rate doesn’t go up.”

For Ms Sahm the sudden fame of her measure has brought with it an additional wrinkle. She had to deal with the world taking her rule in a different direction from her original intention. Ms. Sahm was not trying to get into the forecasting business, much less into timing financial markets. Instead, she wanted to create a benchmark to encourage automatic payments to individuals to protect them from bankruptcy. “A lot of people have asked me if we’re going into recession,” she says. “Almost nobody has asked me what policymakers can do about it.”

Considering the paralysis of Congress, it’s a fair bet that policymakers won’t do much of anything if unemployment continues to rise in the coming months. So Ms. Sahm is now in the awkward position of rooting against her own rule, and hoping for the downfall of America.

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