BY ALMOST any measure, America’s economy is in fine fettle. GDP growth is robust. Unemployment is nearing a 50-year low. And the stockmarket is up by a whopping 50% since 2016. Yet, for all the positive economic news, there is no shortage of hand-wringing on Wall Street about a looming recession. But precisely when will it strike? Economic statistics are often published months after the fact; by the time a recession is officially underway, there is often little investors and policymakers can do about it.
One new clue comes from a new book by Claudia Sahm, an economist at the Federal Reserve, who has developed a new method for predicting economic downturns. In “Recession Ready: Fiscal Policies to Stabilize the American Economy”, Ms Sahm argues that when the three-month average unemployment rate is at least 0.5 percentage points above its minimum from the previous 12 months, the economy is in a recession. This simple measure, it turns out, has correctly called every recession in America since 1970. In January 2008, for example, Ms Sahm’s index warned of the coming Great Recession. The index had also flashed red in early 2001, amid the bursting of the dotcom bubble. Today, conditions are considerably less dire. With unemployment just 0.07 percentage points above its minimum of the past year, the “Sahm recession indicator” suggests that the chance of a downturn occurring in the next year is just 20%.
Ms Sahm’s unemployment-based index resembles many other popular leading indicators. It matches up closely with the slope of the yield curve, which plots interest rates on short- and long-term government bonds, long considered one of the most reliable barometers of economic health. Typically this curve steepens when investors are more bullish on the economy, and expect higher growth and rising interest rates, and flattens (or even inverts) when they anticipate a slowdown. Ms Sahm’s index also matches The Economist’s own “R-word index”, which measures the prospects for a future downturn based on the number of times that newspapers publish the word “recession”. This spikes when recessions are on the minds of traders and the financial journalists who write about them.
Ms Sahm’s measure has some advantages over its peers. It shows clear delineations between periods of recession and growth. It also appears to detect few, if any, false positives. Where her recession indicator falls short is on timeliness. After all, the ability to anticipate a recession is far more useful than knowing when you are in one. The yield curve predicted both the 2001 and 2008 recessions about a year in advance, and the R-word index ticked up at about the same time. The unemployment-based measure, on the other hand, would have given investors a head-start of just a few months. Today, the yield curve suggests that a recession may be imminent and America’s leading newspapers are discussing recessions more often than at any point since 2012. Ms Sahm’s work may soon be put to the test.