Do you remember the 2023 recession? I hope not, because it didn’t happen. But back in 2022 there were so many confident predictions of imminent recession that I wonder whether some people have the vague sense that they must have come true.
Some of these predictions reflected bad economic analysis — the assertion that getting postpandemic inflation under control would be like the disinflation of the 1980s, which required years of high unemployment. I could have told you at the time that this analogy was wrong, and in fact I did. The inflation doomerism of 2022, I’m tempted to say, was the least responsible economic projection, at least by mainstream economists, made in the past 40 years.
But there was also a popular economic indicator that seemed to be flashing red. The yield curve — the spread between interest rates on long-term and short-term government bonds — normally slopes upward, because investors demand a premium for tying up their money for extended periods. When it inverts — when long-term rates are lower than short-term rates — this has historically predicted a recession (recessions are the shaded areas on the chart):
As you can see at the end there, however, in 2022 an inverted yield curve didn’t presage recession. I could talk about why this time was different, but it would take me too far from my current topic. You see, there’s a good chance that this Friday’s employment report will trigger another recession indicator, the Sahm Rule, named after Claudia Sahm, a former Federal Reserve economist who is now an independent consultant.
If so, how should we react? Will this time be different, or will it be another false alarm?
As Sahm has explained, her rule wasn’t designed to predict recessions. It was, instead, meant to serve as a timely indicator that a recession was already underway and that the federal government should move quickly to limit that recession’s depth, for example by sending out stimulus checks.
The underlying logic behind the rule — which I’ll explain in a moment — was the observation that recessions typically involve a cumulative, self-reinforcing process: A modest initial slowdown tends to snowball because it leads to cuts in consumer and business spending. Business investment, in particular, tends to fall sharply in recessions because of the accelerator effect, which says that the level of investment depends on the rate of change of G.D.P.: You only need to buy more equipment, build more offices, etc. when the economy is growing, and you stop doing those things if it isn’t.
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