Action now is key to prevent a recession

[Heather, July 9, 2024, The Washington Post, ‘Opinion-America’s best recession indicator is flashing yellow’, , accessed July 14, 2024, CT]

The best available recession indicator, known as the “Sahm Rule,” holds that when the unemployment rate rises to at least half a percentage point above its low point in the past year, a recession has begun. Today, this indicator is flashing a warning sign for the United States. It doesn’t indicate a recession will definitely happen soon, but it is an important wake-up call, and the Federal Reserve needs to pay attention.

Developed by former Fed economist Claudia Sahm, the rule is based on the idea that, when people start losing jobs, they cut back on spending, and this causes more job losses. Often, the downturn starts slowly. A small rise in unemployment can seem trivial in a labor force of 168 million people. But layoffs can escalate quickly, which is why this indicator has been so accurate over time.

After Friday’s jobs report, the Sahm Rule rose to 0.43. This is uncomfortably close to the recession trigger of 0.5. And it’s more than double the 0.2 level at the start of the year. To put it another way, 800,000 more people are unemployed now than a year ago.

It’s true that, in many ways, the U.S. economy looks great right now. Growth is solid. Inflation has come way down. The stock market is at a record high. Unemployment is a mere 4.1 percent. The economy added more than 200,000 jobs last month, and more people are looking for jobs now than a year ago. Plus, most workers are seeing their paychecks grow more than inflation. Summer vacation travel is also booming, one of the clearest signs households are doing pretty well.

But it’s important to understand that the economy typically looks fine until a crisis hits. The very fact that the economy is in a good place now is reason to take the warning signs seriously — and act to prevent further deterioration.

“We are in the yellow flag category,” Sahm told me. “We should be having a recession risk discussion. It has crossed that threshold.”

Sahm is adamant that the key takeaway from where her rule is now, along with other indicators that the economy is starting to slow — such as rising credit card debt and shoppers spending less — is that the Federal Reserve should cut interest rates. She doesn’t expect the Fed to lower the nearly 5.5 percent rate at its July 30-31 meeting, but she hopes Fed board members have a serious discussion about a September cut.

“By the time it is blatantly obvious we are in a recession, it’s too late for the Fed’s tools to work,” said Sahm, who is now chief economist at New Century Advisors and founder of Sahm Consulting.