How we measure recession is wrong. Here’s a better way to do it
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It helps if we split that figure up by population. When we consider the boom in our population over the past couple of years, we have, indeed, gone backwards. For the past year and a half, GDP growth per person has consistently fallen every quarter.
But to better measure and identify recessions, which we tend to see as a signal for economic pain, we should look to the labour market.
Why? Because that’s where most of the impact of a recession is felt: think about job losses and how hard it is to find a job when the economy is tanking, as well as the impact our jobs have on our lives.
Over the past year, our biggest banks have said it’s our strong labour market which has helped people to muddle through the cost-of-living crisis. We can change our spending habits to keep up with mortgage repayments, or work extra hours to keep up with our rent. It’s not fun, but it’s possible.
Lose your job, though, and life is much harder. It can put people into serious financial stress and damage their mental health.
Enter American economist Dr Claudia Sahm. The tool she developed – called the “Sahm rule” – helps to warn when an economy is entering a recession. It has missed the mark only twice in the past 11 US recessions.
The Sahm formula looks at monthly unemployment data to track how quickly the national unemployment rate is rising compared to the past year. Specifically, it compares the current three-month moving average of the national unemployment rate with the lowest value it has hit in the previous 12 months.
If the current rate is at least 0.5 percentage points higher than the lowest point in the previous year, it means we’re in the early stages of a recession. Measures such as the Sahm rule help us identify weakness in our economy, and the risk of a recession, early. That’s because jobs data is more frequently reported than GDP.
Sahm says changes in the labour market are crucial in understanding the state of the economy.
“If you were put on a desert island and could only have one variable to say what’s going on in the US economy, unemployment is the one you want,” she says. “It really says a lot about whether we’re in good times or bad.”
Sahm’s formula came about in 2019 while she was searching for a better way to fight the next recession. “I had just watched for a decade how hard the Great Recession was on families,” she says. “The goal was to have something people could understand that was very simple, easy to track and really accurate. Your best shot at fighting a recession is to move quickly.”
According to Sahm’s rule, Australia has been in the early stages of a recession for at least one month this year (although the Reserve Bank has argued the Sahm rule should be triggered at 0.75 per cent rather than 0.5 per cent).
When developing the rule, Sahm says she knew from the beginning that examining unemployment would be key. “I already knew, just from my work experience, even small increases in the unemployment rate are a bad sign,” she says.
Australia’s labour market has been remarkably resilient, with the most recent unemployment rate in September coming in at a historically low 4.1 per cent. But we’ve been in – or close to – the danger zone for the past few months.
Why does this matter? Getting on the front foot is important, especially for policymakers such as the government and central banks, to limit the fallout from an economic slowdown.
Independent economist Saul Eslake has long believed the common definition of a recession is flawed. He points to the two consecutive quarters of negative GDP growth in Australia in 1977: “nobody thinks that was a recession,” he says.
On the other hand, Australia didn’t see two consecutive quarters of negative GDP growth during either the global financial crisis or the tech wreck in the early 2000s. But Eslake says Australia arguably faced minor recessions during both those periods.
His own metric for a recession, like Sahm’s, focuses on the labour market. He says a recession should be when unemployment rises by more than 1.5 percentage points in 12 months.
“The biggest impact of a recession is on those who lose their jobs or take a long time to find them,” he says.
“There’s evidence that people who lose their jobs during a recession, or enter the workforce as school-leavers of university graduates during a recession, take longer than normal to find a job.”
This then has a “scarring” effect. Those who lose their jobs, or have difficulty finding one, tend to end up earning less over the rest of their working lives.
The better we are at identifying a recession, the better we can be at protecting jobs and longer-term livelihoods.
Of course, it may not be as simple as just monitoring the jobs market. In the US, for example, the National Bureau of Economic Research (NBER) considers a range of measures beyond GDP – including personal income, employment, wholesale and retail sales – when deciding whether to declare a US recession.
And even Sahm says her rule has limitations, especially as we’ve seen big chances in the supply of labour across many countries.
“This particular economic cycle has challenged simplicity in a way that means these simple rules need some kind of extra check,” she says.
But whether we go with a measure that is simpler than the NBER gauge, more complex than the Sahm rule, or timelier than GDP, it’s clear the focus needs to be greater on jobs.
If there’s one job our economic leaders have, it’s to keep us, as much as possible, in ours.
Ross Gittins unpacks the economy in an exclusive subscriber-only newsletter. Sign up to receive it every Tuesday evening.