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.