Recession warning and the election cycle
Kenneth Galbraith in this commentary argues that the Fed’s policy appears to have engineered a recession:
Unemployment is up almost a full percentage point over the past year, and job creation is way down. The number of newly unemployed, newly employed part-time for economic reasons, and those not in the labor force but wanting a job increased by over a million from June to July. Claudia Sahm’s indicator of recession – a half-point increase in unemployment on a three-month moving average basis – is blinking red. The Sahm rule has held since at least 1960.
Galbraith also highlights the historical pattern of the Fed’s policies being influenced by the presidential election cycle, often tightening more under Democratic presidents.
High Interest Rates Finally Bite
By: James K. Galbraith – University of Texas at Austin
What is the Sahm rule?
Brad DeLong explains how the Sahm rule was developed and gained prominence:
Claudia Sahm introduced the Sahm Rule in May 2019 as part of her policy proposal “Direct Stimulus Payments to Individuals” for the Brookings Institution’s Hamilton Project. The Federal Reserve incorporated the Sahm Rule recession indicator into its Federal Reserve Economic Data (FRED) database in October 2019.
As the COVID-19 recession began, financial analysts and economists started referencing the Sahm Rule for its historical accuracy and simplicity. Its prominence grew after the recession, culminating in a significant moment on December 19, 2022, when Larry Summers cited the Sahm Rule: “Historical experience as encapsulated in the proposition known as the Sahm Rule demonstrates that whenever U.S. unemployment rises by more than half a percent within a year, it goes on to rise by 2 percent…”
In 2024, Federal Reserve Chair Jay Powell mentioned the Sahm Rule during press conferences. The Sahm Rule highlights a critical economic reality: labor market deteriorations are typically rapid. The vicious cycle of falling employment leading to reduced incomes, which in turn lowers spending and further decreases employment, is a well-known macroeconomic failure mode. However, as the Sahm Rule gained traction among financial-market commentators and portfolio managers, its nuances were often overlooked. The rule’s underlying mechanism involves an initial wave of business firings that increases unemployment and significantly reduces incomes.
DeLong finally argues:
You tell me why a Federal Reserve that thinks that the neutral r* is around 3% on a nominal-Treasury Bill basis would keep such rates up at 5% and more, as the economy closed in on its inflation target on what was always a soft-landing glide path.
Well! That Escalated Quickly! A Bad Fed Call Last Wednesday Appears to Have Had Consequences
By: Brad DeLong – UC Berkeley
Should the Fed “placate the markets”?
Maybe, Scott Sumner argues. Risk spreads in the bond market have increased and they are correlated with NGDP growth, as borrowers have more trouble servicing debt when NGDP growth slows sharply.
Suppose the Fed constructed a model to estimate market expectations of NGDP growth, which used a weighted average of all sort of relevant market prices. It might make sense to try to stabilize that index, without trying to stabilize any single individual component of that index. Would that be “placating the markets”? I think that’s sort of a question of terminology. The Fed would not have market stability as a primary goal; rather they would merely be trying to stabilize markets to the extent that doing so would stabilize NGDP growth. As a practical matter, they might occasionally respond to severe stock or bond market movements, but not because they cared about the plight of investors.
Should the Fed Placate the Markets?
By: Scott Sumner – George Mason University
