Federal government shutdowns have, unfortunately, become all too familiar in recent years, casting a cloud of uncertainty over the American economy. As the possibility of yet another political stalemate in Washington looms on the horizon, economists and financial experts have once again turned their gaze toward the potential economic fallout.
Federal government shutdowns have regrettably become a recurring spectacle in recent years. Experts have studied their effects, concluding that, in the short term, the economy can weather the storm without falling into a recession. Economists both on Wall Street and within the Biden administration have conducted assessments, drawing on historical data from past shutdowns.
The general consensus among experts is that a brief government shutdown is unlikely to have a substantial impact on economic growth. This conclusion is grounded in evidence from previous shutdowns, where Congress halted funding for various government operations. The immediate economic fallout from such episodes was relatively limited.
Prolonged Shutdowns: A Growing Concern
However, the real cause for concern lies in the potential for a prolonged shutdown. A protracted shutdown could hamper economic growth and potentially influence President Biden’s re-election prospects. It would join a host of other factors expected to cast shadows on the economy in the final months of the year, including rising interest rates, the resumption of federal student loan payments, and a potentially lengthy United Automobile Workers strike.
Beyond impacting growth, a government shutdown can also dampen consumer confidence. Previous shutdowns have coincided with drops in consumer confidence, with the Conference Board’s measure falling by an average of seven points in the month they began. Although much of this decline typically reverses after reopening, it adds to the overall economic uncertainty.
Gregory Daco, the chief economist at EY-Parthenon, emphasized that while a government shutdown might not be a “game changer” for the economy on its own, the concern is that it could compound other economic headwinds, becoming a significant drag on economic activity.
Jared Bernstein, chairman of the White House Council of Economic Advisers, warned that the internal estimates of his council suggest potential quarterly economic growth losses of 0.1 to 0.2 percentage points for every week a shutdown continues. He added that the impact goes beyond GDP figures, affecting various programs such as Small Business Administration loans, Head Start slots for children, and nutrition assistance for millions.
Goldman Sachs economists have estimated that each week of a shutdown could reduce growth by about 0.2 percentage points. This is primarily because federal workers do not receive pay during shutdowns, leading to an immediate decrease in consumer spending. However, they anticipate a rebound in growth of the same magnitude in the quarter following the shutdown as furloughed employees receive back pay.
Historical data and analyses from prior shutdowns support these estimates. During the 2019 shutdown, for instance, Trump administration economists calculated a reduction in growth of 0.13 percentage points per week.
The 2019 government shutdown, which lasted 35 days, serves as a noteworthy case study in understanding the economic repercussions of such political impasses. Trump administration economists meticulously tracked the economic toll of that extended shutdown and found that it led to a measurable reduction in economic growth. Specifically, they calculated that each passing week of the shutdown resulted in a decrease of 0.13 percentage points in the nation’s economic growth rate.
While most of the lost growth was eventually recovered, it resulted in a modest reduction in annual GDP for that year, amounting to approximately $3 billion.
The good news was that the U.S. economy did manage to recuperate a substantial portion of the lost ground once the government reopened its doors. However, the effects of the shutdown lingered, resulting in a modest reduction in the annual gross domestic product (GDP) for that year. This reduction amounted to approximately $3 billion, a sum that, while not crippling, highlighted the tangible impact that even a relatively short-term government shutdown can have on the nation’s economic output.
The Changing Economic Landscape
However, today’s economic landscape is different, and some economists are less certain that the economy will bounce back as swiftly as it has in the past.
Fast forward to today, and the economic terrain has shifted considerably. The dynamics of the COVID-19 pandemic, coupled with the subsequent economic recovery efforts, have reshaped the way we perceive and respond to economic shocks. Economists are cautious about assuming that the economy will spring back to life with the same vigor it exhibited in the aftermath of the 2019 shutdown.
Concerns are growing that federal workers may not spend as much as they otherwise would have, and government contractors may not fully recoup their lost business.
One of the primary causes for concern is the behavior of federal workers and government contractors during and after a shutdown. Unlike previous episodes, the pandemic has left a lasting imprint on the spending habits and financial security of these groups. Federal workers, who experienced furloughs and reduced income during pandemic-related shutdowns, may exhibit greater caution in their spending during a government shutdown, potentially impacting consumer demand.
Additionally, government contractors, who have endured the ripple effects of the pandemic and supply chain disruptions, might struggle to regain lost business. Their ability to quickly rebound and sustain operations could be hindered, further complicating the recovery process.
In essence, the economic environment today is characterized by a higher level of uncertainty and altered spending patterns, making it difficult to predict with absolute certainty how the economy will respond to a government shutdown of a similar length and scope to that of 2019. These unique factors add complexity to the already intricate web of economic consequences that a shutdown can trigger.
A protracted government shutdown could delay crucial reports on inflation and the job market, which would also have an adverse effect on data release. As a result, Federal Reserve policymakers may become blinded and unable to make wise decisions about interest rates, especially when battling rising inflation.
Suppose for a moment that the government’s statistical apparatus comes to a complete stop. Critical employment and inflation figures, which are the Federal Reserve officials’ compass through the economic maze, abruptly vanish into thin air. That’s exactly the risk that a protracted government shutdown would bring.
Policymakers at the Federal Reserve are left in the dark when government agencies are unable to timely assemble and publish vital economic information. They use this information to determine interest rates and assess the state of the economy. A lack of timely data can impede their capacity to adjust the brakes or speed up economic activity when necessary in the face of quickly growing inflation.
Even though it seems like the economy can withstand a temporary setback, experts warn that growth is predicted to decrease in the last few months of the year. The risks of a recession may intensify if a closure takes longer than expected.
Though appearances can be deceiving, the current state of the economy may appear strong enough to withstand a brief government shutdown. Economists are raising red flags because they anticipate a slowdown in the final few months of the year, which a protracted shutdown could make worse.
With no end in sight to the weeks of uncertainty, the dangers of a recession intensify. Similar to a protracted tug-of-war in the economy, a protracted shutdown has the power to tilt the scales in favor of a recessionary spiral. Businesses, investors, and employees all find themselves in a perilous game of economic chicken, waiting to see how things will turn out.
The head economist at KPMG, Diane Swonk, projects strong GDP growth of over 4% in the third quarter but a decline to about 1% in the fourth.
Swonk’s Economic Projections and Shutdown Impact Analysis
In the midst of this uncertainty, well-known economists have offered their opinions. Diane Swonk is a well-known chief economist at KPMG. Swonk projects a positive picture of the economy for the upcoming quarter, with GDP growth expected to be close to 4%. However, a government shutdown would quickly cause a decrease of about 1% in the fourth quarter as ominous clouds of uncertainty gathered.
If the shutdown lasts for the full quarter, she claims, the effects could be more dire and could even cause the GDP to fall. For now, she says, the two-week shutdown might not have much of an effect.
Swonk is not off in his judgment, particularly in light of how long a government shutdown can last. A brief two-week disruption might only cause minor earthquakes, similar to a passing storm. But if the closure continues unabatedly for a full quarter, there may be considerably worse repercussions.
The seemingly impossible—a drive into negative GDP territory—becomes a real possibility. The extended government shutdown has the potential to destabilize the economy, even during prosperous times. This is a sobering reminder of that fact.
Policymakers and economists are keenly monitoring the situation as a government shutdown looms, both cognizant of the possible economic consequences of a protracted impasse in Washington.
As the possibility of a government shutdown looms large in the distance, economists and policymakers are acting more cautiously. They understand that choices made in the sacred corridors of Washington have the power to impact millions of people’s lives by reverberating through the country’s economy.
Watching the nation and the world closely as politicians play political chicken, everyone is aware of the potential economic downturn that could occur if a resolution is not reached. Higher stakes could not be associated with the fate of the American economy.