With the domestic economy slowing and business confidence at its lowest ebb since the global financial crisis, questions are increasingly being asked about whether New Zealand is on the brink of a recession. According to one measure at least, the ‘Sahm indicator’ suggests there is virtually no chance New Zealand is about to head into a downturn. In fact, the chance of it entering into a recession in the next 12 months is just 10 percent.
An economy officially enters a recession when there is negative real GDP growth for two consecutive quarters (known as a ‘technical recession’). Knowing you are in a recession is one thing but from a policy point of view, it is much more helpful to know in advance when you are likely to enter a recession. That way policy settings can be adjusted to hopefully minimise its impact. In August, the New Zealand central bank took the pre-emptive step of reducing the official cash rate by an unexpectedly large 50 basis points in order to stimulate the economy. With enough lead time, the government can also use fiscal policy levers to boost demand such as through tax cuts, increased welfare spending or kicking off large infrastructure projects.
The Sahm Indicator, developed by US economist Claudia Sahm, has proven incredibly accurate in predicting US economic downturns. So accurate is the predictor that it has correctly predicted every recession in the US since 1970. The Sahm measure states that when the three-month average unemployment rate rises by at least 0.5 percentage points relative to its previous 12-month low, the economy is in recession.
The current unemployment rate in New Zealand is very low — the lowest it’s been since before the 2008 global financial crisis. However, based on the Sahm Indicator it is not the absolute level of unemployment that matters for predicting economic downturns, but rather how rapidly the unemployment rate increases. A rapid, even if relatively small, increase in the unemployment rate has been an accurate indicator that the US is in the grips of a recession.
In New Zealand’s case, the June quarter unemployment rate was 3.9 percent, compared to the previous 12 month low of 4 percent. Because the unemployment rate is below its previous 12-month low, there is almost no chance (1 percent) a recession has already started, with the odds of a recession in the next 12 months only 10 percent. Having said that, when the unemployment rate is not rising, the odds of a recession within two years is still a reasonably high 25 percent.
It is, of course, only one indicator of a potential recession and is based on the US rather than the New Zealand market. Also while the labour market is strong, business surveys increasingly show margins are being squeezed and employment intentions indicate firms may start to shed staff in coming months. For the moment at least, the Sahm indicator suggests the chance of a downturn in the next year is very small.
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