October 4, 2019 / 10:08 AM / 19 days ago

'Sahm Rule' enters Fed lexicon as fast, real-time recession flag

BOSTON (Reuters) - Astronomers get to name comets and biologists get to name species, but come up with something cool in economics and you might be memorialized with a law or a rule or a “curve.”

FILE PHOTO: A man rides his bike past graffiti that reads "Bankruptcy" in Detroit, Michigan, December 3, 2013. REUTERS/Joshua Lott

Introducing the latest: the Sahm Rule, whose architect, Federal Reserve economist and consumer section chief Claudia Sahm, came up with it to flag the onset of recession more quickly than the current process that formally dates business cycles. It also aims to be more dependable than some of the financial market metrics known to throw off false signals.

In a paper released earlier this year, she said the unemployment rate can cut through all that. It is a widely used and easily understood statistic that captures why recessions matter. It also turns out that when the three-month average unemployment rate rises half a percentage point above the low of the previous year, the economy has just or is about to enter a period of contraction.

It has happened every time since the 1970s, Sahm noted in recommending her rule be used as a way to automatically trigger stimulus payments to households to help offset the sting of rising joblessness and potentially shorten the recession without waiting for politicians to sort through the data and vote on a stimulus package.

A variety of such measures, totaling some $420 billion, were used to fight the last recession. Sahm’s aim was to create a program that would get the money rolling quickly, and keep it rolling until the economy stabilized.

The unemployment rule would identify a recession “nearly immediately and long before it has been officially recognized,” Sahm said at a May seminar sponsored by the Washington Center for Equitable Growth on proposals for fighting the next downturn.

The last recession, for example, began in December 2007, but the panel of economists at the National Bureau of Economic Research who date booms and busts did not officially pinpoint that until a full year later.

By contrast, the Sahm Rule hit 0.53 in February 2008 and under her proposal benefits would have started to flow. It peaked at four and did not fall below 0.5 until June of 2010.

While developed as part of a specific proposal for a new “automatic stabilizer,” the Sahm Rule now appears destined for broader use. The St. Louis Federal Reserve on Wednesday added the “Sahm Rule Recession Indicator” to its massive Federal Reserve Economic Data system, FRED, a popular and publicly accessible tool that offers up everything from the number of jobs in Alabama to British inflation since the early 1200s.

“Didn’t even think to put ‘series in FRED’ on my bucket list…excellent,” Sahm, a 2007 University of Michigan PhD, said on Twitter alongside a photo of herself in a FRED t-shirt.

NO RED FLAGS YET

Sahm’s recession indicator currently is well below the level of concern, at just 0.07 percentage point. On average it has been slightly negative since unemployment peaked and began falling in mid-2010, following the end of the deep 2007 to 2009 recession.

But it enters the Fed’s lexicon at a time when debate is focused around the possible onset of recession, and under conditions that may test the rule’s robustness.

The current unemployment rate of 3.7% is considered unnaturally low by many Fed officials, and policymakers in fact expect it to rise about half a percentage point without an actual contraction of gross domestic product.

That rise is expected over several years, but depending on how fast it happens, the Sahm Rule could be breached by a phase of sluggish growth - not the sort of downturn that she feels would warrant annual payments of several hundred dollars per individual until unemployment fell.

Unlike the predictable return of comets or the stable characteristics of a species, economic “rules” may be better characterized as guideposts that can shift over time.

Stanford University professor John Taylor’s “Taylor Rule” for setting interest rates described the Fed’s behavior well for a time, but is not considered so useful when central bank interest rates hit zero, as many have in recent years; Milton Friedman’s “Friedman Rule” for growth in the money supply lost relevance when inflation and money dynamics changed; and even A.W. Phillips famed “Phillips Curve” has lost favor as a practical measure of the tradeoff between inflation and unemployment.

Slideshow (2 Images)

Whether or not Sahm’s rule works as advertised in the future, at least she is in good company.

(GRAPHIC - sahm rule: here)

Reporting by Howard Schneider; Editing by Andrea Ricci

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