Understanding the Sahm Rule

The Sahm Rule is a tool used to identify when an economy is likely to enter a recession based on changes in the unemployment rate. According to the Sahm Rule:

"If the three-month average of the unemployment rate increases by 0.50% or more compared to its lowest point in the previous 12 months, the economy is probably in a recession." – Sahm, Claudia.

This rule is currently tracked by organizations like the Federal Reserve Economic Data (FRED), which provides real-time and revised data.

How Does the Sahm Rule Work?

The Sahm Rule helps spot the early signs of a potential recession by examining the unemployment rate. Here’s how it works in three simple steps:

1. First, compute the average unemployment rate over the last three months.

2. Next, find the lowest three-month average of the unemployment rate from the previous 12 months. Suppose the lowest average over the past year was 3.5%.

3. Finally, compare the latest three-month average with the lowest three-month average from the past year. If the latest average is at least 0.50% higher than the lowest average, the Sahm Rule indicates that the economy might be entering a recession.

Example

Assume that in January, February, and March, the unemployment rates were 4.0%, 4.1%, and 4.2%, respectively. The latest three-month average is calculated as follows:

Latest three-month average = (4.0% + 4.1% + 4.2%) / 3 = 4.1%

If the lowest three-month average over the past year was 3.5%, we compare the two:

  • Latest three-month average: 4.1%

  • Lowest three-month average in the past year: 3.5%

  • Difference: 0.6%

Since the difference (0.6%) exceeds the 0.5% threshold, the Sahm Rule would indicate that the economy is likely entering a recession.

Learn more: Sahm Rule.