The origin, use of the Fed's Sahm Rule recession indicator

The Sahm Rule is a recession indicator that tracks the shifts in the US unemployment rate, comparing a three-month average of unemployment data to the past 12 months. Former Federal Reserve Board economist Claudia Sahm — whom the rule is named after — explains the origin of the indicator:

"The reason the indicator exists is I had a policy proposal to start fiscal stimulus, send out stimulus checks, in particular, as soon as a recession hits. So have kind of that front line defense against recessions to help people and get it tied to economic conditions. So it just goes out the door when it's time"

Sahm, who is also the founder of Sahm Consulting, states the rule is not for helping the Fed to make interest rate policy decisions because "[those] take more time to work." Sahm goes on to weigh that it may be time for the Fed to gradually reduce rates as "risks are building" now.

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This post was written by Luke Carberry Mogan.

Video Transcript

I'm just interested.

Why did you create um the P A rule in the first place?

What was sort of the motivator there and to the extent that it has worked that it's, it's reliable.

Uh Can you quantify that Claudia for what, what's the, what's the batting average there?

I did not get in this business to like uh pontificate about recessions.

And if they were here coming, the, the, the reason the indicator exists is I had a policy proposal to start fiscal stimulus, send out stimulus checks and in particular as soon as a recession hits so have kind of that, that front line defense against recessions to help people and get a t economic condition.

So it just goes out the door when it's time and that, that was the reason and that's why it needed to be simple, wants to be legislation and it needs to be highly reliable because it was to help drive policy and it was designed for fiscal policy which can act very quickly having it in a discussion about what should the fed do, is it time to cut interest rates?

It's not what that tool is thinking about because fed policy, interest rates, they take more time to work.

You would never, if I were to design an indicator for the fed, it would not be one like the Psalm rule because it's much more in, in the moment.

So Claudia to be clear, you think the fed should start cutting in September, right?

You don't think they should wait for the Psalm rule to be triggered.

The fed.

I think the fed has a very good case to begin a gradual reduction in interest rates based on the path of inflation itself that we have made a lot of progress.

And you want to be able to do this gradually and the fed should be out of the way, so to speak, by the time we get to the 2% target, and it's to me, it's very clear looking at the data, looking through a lot of the noise that we had to begin this year that where we are headed and we want to do this gradually.

And I think the risks are building particularly now that the, that the uh labor market has showed some.

Then the labor market has quote normalized.

Like we're really kind of back to where we were before the pandemic, which was a very good place for the labor market.

And inflation has not totally but largely normalized.

It's made a lot of progress to 2%.

The one thing that has not begun to normalize is the federal funds rate.

So, you know, getting all of that synced up together is the, the feds next challenge.

And I given what we know, now it's appropriate for the Federal Reserve to get going on the cuts.