In Brief: Unemployment, Interest Rates, and the Sahm Rule
A recession indicator has been triggered, but two other historical issues make the economic outlook more complicated.
July’s jobs numbers were worrying news for the economy, with an underwhelming 114,000 jobs added while unemployment keeps rising — now up to 4.3%.
National Review fellow Dominic Pino observes that the slowing job growth and increasing unemployment rate have triggered the Sahm rule. Ergo, the Federal Reserve will feel growing pressure to cut interest rates.
The Sahm rule says that a recession is beginning when the three-month average of the unemployment rate is 0.5 percentage points greater than the twelve-month low point. Now we know that the average of May, June, and July is 0.53 percentage points greater than the twelve-month low point.
One purpose of the Sahm rule is to allow for a more forward-looking recession indicator. Other recession indicators, such as two consecutive quarters of GDP contraction, are by definition backward-looking. The Business Cycle Dating Committee of the National Bureau of Economic Research is primarily engaged in economic history, not policy-making. The Sahm rule is supposed to help the Fed and Congress to respond to the economy in real time.
Once the Sahm rule is triggered, the theory is that it will help both Congress and the Fed work to tailor “monetary and fiscal policy in real time to respond to recessions before they get out of hand.”
The Sahm rule has a very good historical record of predicting recessions, so it’s not insignificant that it has been triggered. But there are two other historical issues that complicate things.
The first is that, prior to basically right now, nobody would think that a 4.3 percent unemployment rate was a worrying sign of impending recession. For decades, about 4 percent was considered full employment. It was feared that going below that would cause an increase in inflation. Also, there will always be unemployed people, even in a really good economy, because people will still switch jobs and be unemployed briefly in between.
For example, in the 1980s, the unemployment rate never dropped below 5%, and throughout the prosperous 1990s, it fluctuated between 5% and 6%.
The second issue is that interest rates are not historically high. They’re pretty normal now. They only feel high because they were historically low in the 2010s.
Today's average 30-year fixed mortgage rate of 6.73 percent is lower than it was at any point from when data begin in 1971 all the way through October 1998. The average mortgage rate was right around 6 percent for most of the 2000s. The borrowing costs homebuyers currently face are not unusual. What was unusual was the free-money period of the 2010s.
Pino concludes:
But those decisions should be informed primarily by metrics such as the NGDP gap and inflation expectations, not by an unemployment rate of 4.3 percent or historically normal interest rates.
