15: The Sahm Rule
We are in a recession. And it's going to be HUGE.
Hello, friends,
As Olivier Blanchard tweeted “The world is de facto at war against the virus.” This formulation matters coming from the former chief economist of the International Monetary Fund (2008-2015). Wartime mobilization regarding medical capacity and vaccine funding, public shutdowns, home isolation, and so forth—the facts on the ground require creative thinking - a whole of society, whole of government, whole of everything approach. This is a “yes and” situation when it comes to fiscal, monetary, private, and public tools.
If I continue to cover the SARS-CoV-2 (and COVID-19) crisis in this newsletter I hope to engage with solutions since many of the past newsletters were devoted to describing the slow-moving hurricane that was building up and that we are now living through. Description gives way to prescription.
Today I’d like to briefly (as briefly as I can) describe the Sahm Rule and what that implies for our economy up ahead.
A-ha! - The Sahm Rule
~Aha! is a column which I discuss terms that illuminate the way through~
Preliminary unemployment numbers show that more people filed for unemployment last week “than in any previous week in the nation’s history, shattering a record set back in 1982” (The New York Times Editorial Board). Unemployment numbers can lag a bit, and we have only just begun our economic shutdown. The county I live in, for example, begins implementing a “shelter in place” order tonight at midnight. The unemployment numbers indication is glaring and horrifying. Normally economic recessions are considered in full-swing when there are two consecutive quarters of declining economic growth.
Economist Claudia R. Sahm, formerly a Section Chief at the Board of Governors of the Federal Reserve System, constructed the “Sahm rule,” as a way to gauge when we are beginning to enter a recession by looking at increases of unemployment by quarter and then by year. If the unemployment rate is up “by at least 0.5 percentage point above its low point in the previous 12 months”: recession; if unemployment increases by 2 percentage points or more in a year: deep recession. According to Jason Furman in an article for The Wall Street Journal “this rule has signaled every recession since 1970 with virtually no false positives.” Sahm in a paper just released notes that this metric only failed to predict the onset of a recession in 1959; the recession came six months later, however. This is a phenomenal track record that has had fewer “false positives” than other indicators such as the “yield curve,” according to Sahm (2020). (Though Barron’s is showing that the “yield curve” right now is definitely indicating a recession; couple that with the Sahm Rule and we can be quite confident here.)
Sahm has recommended that the federal government use her rule and build it into “automatic stabilizers,” programs that kick in countercyclically, e.g., unemployment insurance, and progressive income taxes. These are automatic mechanisms that activate without additional legislation. When unemployment begins to tick upwards, Sahm argues, automatic stimulus should kick in. This is absolutely a brilliant, simple, and awesome idea! But so far her idea has gone unheeded by Congress. And here we are now discussing her idea in a moment of crisis.
Sahm points the start of a recession to the peak of economic expansions; by that metric, she argues we are likely headed for a huge recession - and this contraction could be larger than the Great Recession (2007-2009). In an earlier blog post—called “Send People Money. Now.”—she argued we should treat SARS-CoV2 (and COVID-19) as if we are trying to slow and stop a recession, even if we weren’t precisely in one yet. Now, just a few days ago on Macro Musings, she is comfortable with saying that we are currently in the beginnings of a recession. In “Send People Money. Now.,” Sahm argues that we need to pull out all the stops for this one, on all levels of government: President Trump could issue an executive order that cuts federal tax withholding; the Federal Reserve (FED) could cut interest rates (they did this); the FED could also itself finance fiscal policy, which, she admits, has never been done before. This tool is called “Money-Financed Fiscal Program (MFFP),” by Ben Bernanke, former Chair of the Federal Reserve from 2006-2014.
MFFP and “Helicopter Money”
This MFFP tool is a way to increase the money supply without using conventional fiscal policy (U.S. federal debt). This could happen in two ways:
(1) “Congress approves a $100 billion one-time fiscal program, which consists of a $50 billion increase in public works spending and a $50 billion one-time tax rebate (generic example that would be tailored to specific situation, my emphasis and parenthetical). In the first instance, this program raises the federal budget deficit by $100 billion. However, unlike standard fiscal programs, the increase in the deficit is not paid for by issuance of new government debt to the public. Instead, the Fed credits the Treasury with $100 billion in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate.”
OR(2) “The U.S. Treasury could issue $100 billion in debt, which the Fed agrees to purchase and hold indefinitely, rebating any interest received to the Treasury.”
Source: Ben Bernanke’s blog.
This intervention is called “helicopter money,” or “direct, unrepayable funding by the central bank of the additional fiscal transfers deemed necessary” (Gali 2020, 59). Bernanke details implementation hurdles and issues that are beyond the goal of this newsletter which is to briefly review potential macroeconomic solutions to SARS-CoV-2 and the deliberate shutting down of our economy. Rules and legislation might need to be changed (particularly updates to the Federal Reserve Act). However, economic theory shows that “helicopter money” or “helicopter drops” can be used in times of emergency; this is an emergency:
To be sure, the FED has already done a lot: Cut policy rates to 0%-0.25%; issued forward guidance on these rate cuts; announced it would buy $500 billion in Treasuries and $200 billion of mortgage-backed securities; dropped its discount rate (interest rate given to commercial lenders); encouraged banks to use “intraday credit,” which allows more day-to-day activity with less financial risk; has encouraged banks to use capital “buffers”; and loosened reserve requirements (see this excellent blog).
The FED as an institution is limited in its capacity. This is why fiscal and private-sector actors must do more, too.
As I write this, Congress is debating a massive stimulus package and passed and the President signed an earlier bill that began the fiscal fight. We need way more fiscal stimulus and we need it now. We need loan guarantees and increased unemployment insurance with no job-search requirements. We need the federal government to match funding for increased Medicaid enrollment for all 50 states and territories. A Senate proposal sponsored by Democrat Bob Menendez (NJ) would amend the Federal Reserve Act. It would allow the FED to buy municipal debt (local and state) “of any maturity,” easing the fiscal straitjackets that states normally live under due to federalism. These are just a few quick examples of creative, important, and necessary ideas in an unprecedented global crisis.
Good Resources on the Sahm Rule
Beckworth, David. 2020. “Claudia Sahm on Direct Payments to Individuals and Other Policy Responses to the COVID-19 Crisis.” Mercatus Center: The Bridge (March 18).
- This is a transcript of the podcast episode of Macro Musings with David Beckworth from March 16.
The Duomo Initiative breaking down the Sahm Rule in a short video column called “Explained in 3 Minutes”:
Sahm, Claudia. 2019. “Direct Stimulus Payments to Households.” The Hamilton Project, from The Brookings Institution (May 16). - A paper from Sahm herself. It’s excellent.
We need so many solutions and creative innovations right now and in future SARS-CoV-2 newsletters, I will dive into more of these. This newsletter will aim to be solutions-driven at this point in the timeline we are on. Later newsletters can begin to assess how the world and international politics look in a post-COVID world. For now, solutions!
~
Keep socially isolating (but Skyping your friends and families!),
Patrick M. Foran