The SAHM rule is a widely recognized economic indicator that signals the early stages of a recession by monitoring changes in the unemployment rate.
What is the SAHM Rule?
The SAHM rule, developed by former Federal Reserve economist Claudia Sahm, is a simple yet powerful recession indicator. It states that an economy is in the early months of a recession when the three-month moving average of the national unemployment rate is 0.5 percentage point or more above its low over the prior twelve months. This rule provides a timely signal of economic contraction, often before official recession declarations.
Origins and Purpose
The SAHM rule was created to provide a real-time, data-driven signal of economic downturns. Traditional recession announcements by the National Bureau of Economic Research (NBER) often come with a significant lag. Claudia Sahm's goal was to identify a reliable trigger that could alert policymakers and the public to an impending or ongoing recession much earlier, allowing for a more rapid response.
How the SAHM Rule Works
The rule operates on a clear, data-driven mechanism based on the national unemployment rate, which is a key economic indicator.
- Baseline Calculation: First, the rule identifies the lowest point of the national unemployment rate within the past 12 months. This serves as the benchmark.
- Moving Average: Simultaneously, it calculates the three-month moving average of the national unemployment rate. This smooths out short-term fluctuations, providing a clearer trend.
- Threshold Trigger: A recession signal is triggered when this three-month moving average of the unemployment rate rises by 0.5 percentage points or more above that 12-month low.
Example:
If the lowest unemployment rate in the past 12 months was 3.5%, the SAHM rule would signal a recession if the three-month moving average of the unemployment rate reaches 4.0% (3.5% + 0.5%) or higher.
Significance and Reliability
The SAHM rule has historically been a reliable indicator of recessions in the United States, accurately flagging every U.S. recession since 1970 with minimal false positives. Its timely nature makes it a valuable tool for:
- Policymakers: It can prompt earlier consideration and implementation of fiscal and monetary policy responses to mitigate the severity of economic downturns.
- Economists and Analysts: It offers a simple, transparent metric for assessing the current state and trajectory of the economy.
- Businesses and Individuals: While not a personal financial advisor, understanding this indicator can help inform planning and decision-making during periods of economic uncertainty.
Limitations and Considerations
While highly effective, it's important to remember that the SAHM rule is an indicator, not a definitive predictor of all economic challenges. It signals when a recession is likely underway or just beginning, rather than forecasting its onset far in advance. Other economic factors and data points are also considered by economists to gain a comprehensive view of economic health.
