Opinion: The best indicator of a US recession is flashing yellow

Has been updated: 1 1 hour ago release date: 1 1 hour ago

The best recession indicator, known as the “Sum Rule,” says a recession begins when the unemployment rate rises by at least half a percentage point above its lowest level in the past year. Currently, this indicator is sounding a warning in the U.S. While it doesn’t mean a recession is definitely on the way, it is an important wake-up call and one the Federal Reserve should pay attention to.

Developed by former Fed economist Claudia Thurm, the rule is based on the idea that when people start losing their jobs, they cut back on spending, which causes further job losses. Recessions often start slowly. In a workforce of 168 million people, a small increase in the unemployment rate may seem insignificant. But layoffs can grow quickly, which is why this indicator has been so accurate for so long.

After Friday’s jobs report, the Sumrul index rose to 0.43, very close to the 0.5 threshold that would trigger a recession, and more than double the 0.2 reading at the start of the year. In other words, there are now 800,000 more unemployed people than there were a year ago.

Indeed, in many ways, the U.S. economy looks good right now. Growth is strong. Inflation is significantly lower. The stock market is at an all-time high. The unemployment rate is just 4.1%. More than 200,000 jobs were added in June, and more people are looking for work than a year ago. Plus, most workers’ wages are growing faster than inflation. Summer travel is booming, one of the clearest signs that households are doing pretty well.

But it’s important to understand that the economy generally looks good until a crisis hits. The fact that the economy is currently doing well is itself a reason to take warning signs seriously and act to prevent further deterioration.

“We’re in the yellow light category,” Sam told me. “We should be talking about recession risk. We’ve crossed that threshold.”

Sam asserts that the key lesson from current policy, along with other indicators that the economy is starting to slow, such as rising credit card debt and reduced spending by shoppers, is that the Fed should lower interest rates. He doesn’t expect the Fed to cut interest rates, which are around 5.5%, at its July 30-31 meeting, but he does expect Fed board members to seriously discuss a rate cut in September.

“By the time it becomes clear we’re in a recession, it’s too late for the Fed’s policy tools to take effect,” said Sam, now chief economist at New Century Advisors and founder of Sam Consulting.

Fed leaders continue to insist that it would be better to end inflation once and for all, even if it meant keeping interest rates too high for too long and causing a recession. It will be interesting to hear what Fed Chairman Jerome H. Powell has to say when he testifies before Congress this week. A month ago, he called the job market “robust.” Will he downgrade it to “robust”? And will he start emphasizing the risk of a recession if the Fed is too stubborn to change course?

Perhaps the trickiest question is whether Samrul is wrong this time, given the recent surge in immigration. Business leaders and economists are quick to point out that immigrants have contributed to the recent economic boom: They filled jobs no one else wanted and allowed companies to expand. But immigrants are hard to measure precisely: They are some of the least likely to respond to government surveys. The unemployment rate is based on household surveys, and response rates have fallen substantially since the pandemic. A better count of immigrants could make the unemployment rate lower. Either way, the unemployment rate has been slowly rising for the past year, making the trend hard to ignore.

If it were possible to “pause” the economy right now and keep it going, most would say we should. The economy is growing at a healthy pace, jobs are still plentiful, inflation has subsided, and consumers are starting to find deals and bargains again. Unfortunately, a pause is not possible as long as the Fed is still squeezing the economy.

The Federal Reserve has a tool to avert a recession and protect jobs: it can start cutting interest rates.

Heather Long He is a columnist and editorial board member at The Washington Post, where he served as U.S. economics correspondent from 2017 to 2021. Prior to that, he was a senior economics correspondent at CNN and a columnist and deputy editor at The Patriot-News in Harrisburg, Pennsylvania. He worked for an investment firm in London and was a Rhodes Scholar.

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