Understanding the Sahm Rule (with economist Claudia Sahm)

Episode Summary

Executive Summary: Economist Claudia Somm argues that inflation has improved meaningfully without a recession, unemployment is still low, and the widely discussed “Somm rule” has not actually been triggered yet. The conversation clarifies recession definitions, criticizes overreliance on the Fed, and emphasizes that policy should prioritize workers, the middle class, and automatic stabilizers rather than headline panic.

Main Topics: Inflation update and CPI results (Priority: 5/5): Somm explains that the latest CPI report was better than expected: monthly prices were flat, core inflation rose less than forecast, and annual inflation has fallen substantially from its peak though still remains above pre-pandemic levels. What the Somm rule is—and is not (Priority: 5/5): She clarifies that her recession indicator is based on the unemployment rate’s three-month average versus its 12-month low, designed to trigger automatic relief, not to forecast recession headlines. Recession definition and GDP confusion (Priority: 4/5): The hosts and Somm distinguish a true recession as a broad-based contraction in economic activity, noting that two negative GDP quarters in 2022 were misleading and did not reflect a standard recession. Labor market strength and risks (Priority: 5/5): Despite a rising unemployment rate, she stresses that labor market conditions remain strong, wage gains have improved, and some increases reflect workers returning and temporary adjustments rather than collapse. Limits of the Federal Reserve (Priority: 5/5): Somm argues the Fed cannot solve inflation alone without causing job losses, especially because it cannot directly address food, gas, or housing inflation; Congress and executive policy must share responsibility. Middle-class policy and automatic stabilizers (Priority: 4/5): She links low unemployment to worker well-being and argues for automatic supports like stimulus checks and child tax credits that activate based on conditions rather than political delay. Why the 2% inflation target is contested (Priority: 3/5): Somm explains that the 2% target is historically contingent and partly arbitrary, with CPI normalizing closer to 2.5% and the Fed unlikely to change its target soon.

Key Arguments: Inflation has meaningfully improved in 2023 without triggering mass unemployment, which is unusually favorable compared with typical anti-inflation episodes. The Somm rule is a recession trigger for automatic stabilizers, not a predictive recession model; a small unemployment increase alone does not necessarily mean recession. The unemployment rate is the best broad proxy for middle-class well-being because most households depend on paychecks and benefit from a tight labor market through wage gains and job mobility. GDP alone can mislead; broad recession calls should consider multiple indicators such as payrolls, income, industrial production, and spending, not just two negative GDP quarters. The Fed can influence demand but cannot directly lower essential-price inflation without hurting jobs; inflation policy requires fiscal, energy, and administrative tools too. Automatic stabilizers and predesigned relief programs would be more effective than ad hoc crisis policymaking because they can deliver help faster and more fairly. The labor market has produced broad gains, including for women, Black men, people with disabilities, and workers with less education, showing that strong labor demand reduces inequality.

Data Points: Monthly CPI change: 0% - Prices were flat month over month in the latest CPI report. Core inflation monthly change: 0.2% - Core inflation rose two-tenths instead of the expected three-tenths. Annual total inflation: ~3% - Inflation remains above pre-pandemic norms but far below its peak. Annual core inflation: ~4% - Core inflation is still elevated relative to pre-pandemic levels. Unemployment rate (three-month average): 3.8% - Used in the Somm rule calculation at the time of the discussion. Lowest unemployment over prior 12 months (three-month series): 3.5% - Benchmark for the Somm rule’s recession trigger calculation. Somm rule gap: 0.3 percentage points - Three-month average unemployment above the prior 12-month low. Monthly unemployment rate: 3.9% - This reading prompted social media discussion about whether the rule had triggered. Lowest monthly unemployment over prior 12 months: 3.4% - This makes the monthly gap equal to the rule’s 0.5-point trigger threshold. Somm rule trigger threshold: 0.5 percentage points - Threshold difference between current unemployment and prior 12-month low. Historical GDP downturn pattern: 2 consecutive quarters - Traditionally associated with recession, but not always a valid recession definition in the U.S. Typical SOM-rule recession rise: ~2 percentage points - In the mild 2001 recession, unemployment rose by about this amount after triggering. Typical recession unemployment rise: ~4 percentage points - Somm contrasts mild vs. typical recessions to show current rise is small.

Pivotal Quotes: "The unemployment rate is, I mean, it's widely followed. People understand it. And it's the reason that we fight recessions." — Claudia Somm: Explaining why she built her recession indicator around unemployment rather than GDP. "I don't want to judge anybody. But this has been a hard – it's hard to know where we are, let alone where we're going. But we're going in a good direction now." — Claudia Somm: Reflecting on pandemic-era uncertainty and the improvement in inflation and labor-market conditions. "It's not a recession. When the SOM rule has triggered in all of these prior recessions... it went up by 2 percentage points." — Claudia Somm: Clarifying that current unemployment movements are too small to imply a recession even if the rule triggers.

Implications: Listeners should read labor-market headlines carefully: a small unemployment rise does not automatically mean recession. The bigger lesson is that workers need faster, automatic policy support, and broader economic success should be judged by middle-class well-being, not just GDP or inflation headlines.