Recruiters are on the front lines of a weakening labor market. Some economic indicators suggest a recession, but will it be different this time?

How Do We Know Whether We Are in a Recession?

If you’re in recruiting, you have likely noticed the downturn in hiring and might even be concerned that it could spiral into a recession (or that already has). Unfortunately, it is not easy for economists to determine whether an economy is in a recession in real time, as most economic indicators are published with a substantial lag.

For instance, quarterly GDP data is released more than a month after the quarter ends. Other economic data, like employment statistics, are published monthly, but data revisions can completely change the picture of what was happening.

In 2008, for example, the Federal Reserve, America’s central bank, did not recognize that the economy was in recession until the fall, even though economists later determined the recession had started as early as January. One problem the Fed faced was that employment data initially painted a much rosier picture than the revised data showed many months later.

Believe it or not, there is a debate on how to define a recession. The media typically refers to a recession as two consecutive quarters of negative GDP growth, a rule of thumb that originated on Wall Street. However, the official recession call comes from the National Bureau of Economic Research (NBER) recession dating committee, which uses several macroeconomic indicators and considers both the depth and the duration of the contraction. Months after the recession has started, the committee releases its findings.

The Unemployment Rate Typically Rises During a Recession

Historically, U.S. recessions have coincided with a significant increase in the unemployment rate. However, this isn’t always the case in other countries, where the labor market may not weaken as much during downturns.

This difference can be attributed to varying institutional setup. European labor markets are more rigid, and job security is much stronger. Companies are therefore less willing to engage in layoffs immediately, even in tough times. Moreover, many advanced economies face severe worker shortages due to adverse demographic developments. A stagnating or shrinking labor force makes companies even more reluctant to let workers go, as hiring becomes more difficult when the economy picks up again. This phenomenon, known as “labor hoarding,” explains why some countries only observe small increases in unemployment during economic downturns.

In contrast, every single postwar recession in the U.S. has coincided with an increase in unemployment by several percentage points. The U.S. labor market is much more flexible, allowing American companies to let people go more easily when the economy turns downward. Likewise, it is easier to rehire when the economy improves.

Based on this observation, economist Claudia Sahm has devised a recession rule: When the three-month moving average of the unemployment rate exceeds its previous 12-month minimum by 0.5 percentage points, the U.S. economy has entered a downturn.

Over the last year and a half, the U.S. unemployment rate has risen from a low of about 3.4% in early 2023 to 4.3% more recently, triggering the so-called Sahm rule, which has accurately identified every single postwar recession since the 1950s.

Why This Time Might Be Different

Even though the Sahm rule was triggered in July, there are reasons to believe that this recession indicator might not be accurate this time.

Firstly, GDP growth in the U.S. has been relatively strong in the first two quarters, running at a rate of more than two percent. Other economic indicators – including ones used by the NBER – also currently do not point toward a downturn. While Americans have been pessimistic about the economy for more than two years due to high inflation, actions speak louder than words: Americans’ actions do not suggest an economic downturn. Personal spending is increasing as consumers continue to splurge, driving record retail sales in recent months. Booking data show that Americans are taking more trips than before.

But there are also some warning signs. Poorer households are indeed struggling more right now and are cutting back on spending.

The labor market has noticeably slowed as well. While net job creation has been positive throughout the year, it has become more difficult to find a job, particularly in some white-collar roles, especially in the tech sector, consulting, media and marketing, and similar professional occupations. After the post-pandemic hiring surge, many companies have now cut back or even frozen hiring entirely. For now, the employment rate remains at its highest in decades, indicating that most Americans who want a job have one. But changing jobs has become much harder as the labor market weakens.

That said, the increase in the unemployment rate that triggered the Sahm rule is not due to widespread layoffs. In fact, layoffs remain historically low.

What’s contributing to the rising unemployment rate is a historic surge in migration.

Estimates suggest that more than 5 million immigrants have arrived over the last two years, many of them arriving illegally. This massive increase in the workforce helps explain the worker boom the U.S. labor market has seen since 2022, as well as why the unemployment rate has started to increase.

With the native workforce aging rapidly, the migration surge has massively boosted the available labor supply by more than four million since 2022, creating lots of new jobs. But even with the U.S. labor market being more flexible, not every worker can find a job right away, thus explaining the gradual increase in unemployment since then.

What Does That Mean for Recruiters?

The Sahm rule has been triggered this time because of the worker surge, not because companies are laying people off. Nevertheless, economists now believe that the Fed needs to lower interest rates soon from their current high level to support a weakening economy.

Historically, sluggish Fed policy has contributed to or caused many recessions. But with the Sahm rule being triggered, even for a benign reason, Fed policy makers will hopefully be more aware of the risks and ease monetary policy soon, starting with a rate cut in September. This would mean that even as the unemployment rate rises, it will hopefully stabilize below 5% while the economy continues to grow. This would be the first ever “mini-recession” for the U.S. labor market.

For now, recruiters should be aware of two things. First, compared to two years ago, hiring has gotten easier and less costly, thanks to the massive surge in labor supply. Second, despite all the recent recession talk in the media, the U.S. economy is not in a recession yet! There is a very good chance we can avoid one, depending on future monetary policy and interest rate decisions by the Fed.

Author Bio

Julius Probst, Ph.D., is European Labor Economist at Appcast.

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