"a Federal Reserve economist has come up with a simple rule based on movements in unemployment to rapidly determine when a recession is under way. In conjunction with that rule, Claudia Sahm has also proposed policies to immediately soften the downturn without the political hurdles that usually slow stimulus efforts."
"In January 2008, Fed officials projected the flagging U.S. economy would avoid a recession. Fed staff believed the probability of recession within the next six months was 45%, according to a policy meeting transcript.
In fact, a recession had begun the previous month, a determination the official arbiter, the National Bureau of Economic Research—a nonpartisan, nonprofit academic network—would take almost a year to make. It took six to 21 months to call previous recessions.
“That’s too long for stabilization policy to wait,” Ms. Sahm said on Twitter earlier this year. “Stimulus early could help reduce the severity of a downturn.”
The unemployment rate has risen sharply in every recession, and thus economists have long looked for recession signals in its behavior. Ms. Sahm spent weekends playing with a massive spreadsheet, testing different rates of increase over varying periods of time, to arrive at the following formula: If the average of unemployment rate over three months rises a half-percentage point or more above its low over the previous year, the economy is in a recession.
Her formula would have accurately called every recession since 1970 within two to four months of when it started, with no false positives, which could trigger unnecessary and costly fiscal stimulus.
Ms. Sahm says her rule is based on historical relationships in the U.S. and thus can’t be applied to other countries or individual states, whose labor markets may behave differently."
"Ms. Sahm proposed that the Treasury begin sending payments to households equal to 0.7% of gross domestic product, or 1% of consumer spending, when the Sahm rule trigger is met, and extend those payments in subsequent years if the unemployment rate increases at least 2 percentage points above the level at the time of the first payment, then gradually scaling them back as the jobless rate declines.
Under her proposal, payments in the last recession would have started in April 2008 and continued into 2013, after the last of the big household stimulus programs expired. The boost to spending in 2008 and 2009 together would have been about 50% larger than under the stimulus actually enacted, she estimated.
Expanding automatic stabilizers this way could have drawbacks, warns Douglas Holtz-Eakin, president of the American Action Forum, a right-of-center think tank, and former Congressional Budget Office director. They would boost mandatory spending, which already weighs on the federal budget, and lawmakers would still face political pressure to respond with additional discretionary stimulus, he said."
Economist Scott Sumner seems to agree with the rule. See Sahm’s Rule and mini-recessions. Excerpts:
"Sahm suggested that she got the idea from Jason Furman, who heard about the idea from Doug Elmendorf.
Back in 2011, I had a similar insight in a blog post on mini-recessions (or more specifically the lack of mini-recessions):
I searched the postwar data, which starts at 1948 and covers 11 recessions. During expansions I found only 12 occasions where the unemployment rate rose by more than 0.6%. In 11 cases the terminal date was during a recession. In other words, if you see the unemployment rate rise by more than 0.6%, you can be pretty sure we are entering an recession. The exception was during 1959, when unemployment rose by 0.8% during the nationwide steel strike, and then fell right back down a few months later. That’s not called a recession (and shouldn’t be in my view.) Oddly, unemployment had risen by exactly 0.6% above the Bush expansion low point by December 2007 (when the current recession began) and by 0.7% by March 2008, and yet many economists didn’t predict a recession until mid-2008, or even later.
Now here’s one of the most striking facts about US business cycles. When the unemployment rate does rise by more than 0.6%, it keeps going up and up and up. With the exception of the 1959 steel strike, there are no mini-recessions in the US. The smallest recession occurred in 1980, when the unemployment rate rose 2.2% above the Carter expansion lows. That’s a huge gap, almost nothing between 0.6% and 2.2%.
Sahm’s formulation is superior to mine because the month-to-month unemployment rate is noisy. By taking a three-month average in measured unemployment she gets a better view of the underlying trend in actual unemployment."
"The FT argued that the Sahm indicator doesn’t really “predict” recessions, as it’s a coincident indicator. But even that is highly useful, as we often don’t know that we are in a recession until 6 to 9 months after it began. The most recent recession began in December 2007, but as late as August 2008 the Fed didn’t even know we were in a recession. By that time, the Sahm rule had been indicating a recession for months.
The Sahm Rule has a deep connection to the mini-recession mystery. The rule works in the US precisely because we never have any mini-recessions (for some unknown and deeply mysterious reason.) It doesn’t always work in foreign countries because they do have mini-recessions."
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