The economics of another U.S. government shutdown

REAL ECONOMY BLOG | September 26, 2023

Authored by RSM US LLP

The impasse over funding the federal government involves a small group of 20 hardliners in the House of Representative majority who are making demands reminiscent of 2018, when the government shut down for approximately five weeks.

The traditional 12 annual appropriations bills that account for federal spending have not been written. Congress, at a minimum, will need to put together a continuing resolution to fund government operations until those bills can be written, voted upon and enacted.

Should the House majority not find a way to agree on a continuing resolution, the federal government will shut down on Oct. 1.

Eight months after enactment of the Fiscal Responsibility Act that ended the standoff over raising the nation’s debt ceiling, lawmakers are again embroiled in a dispute over funding the government. A shutdown will hurt the economy, placing a drag on spending and overall economic activity as we approach the traditional holiday season.

Just as important, the standoff could again result in another downgrade in the U.S. credit rating, which in April was lowered by the ratings agency Fitch, which cited political polarization.

The economic cost is clear, even if it is modest: Each week that the federal government is shut down would exert a 0.2 percentage point drag on gross domestic product, in our estimation.

We anticipate that once the shutdown starts, it would linger on for a week or two before an agreement on a short-term continuing resolution can be reached in lieu of an omnibus bill that would fund all of the traditional 12 appropriations bills.

Given the level of rancor inside the GOP House majority, we would not be surprised to observe a five-week shutdown like the one in 2018. That impasse ultimately did not result in any reduction in spending and simply reverted to previously agreed upon spending agreements.

Because of the number of government shutdowns over the past two decades, estimating the economic impact of these events has become a rather sterile affair.

A shutdown at this point would involve roughly 800,000 of the 4 million federal government workers and hundreds of thousands of federal subcontractors.

While all workers will not get paid until the impasse is resolved, only those 800,000 deemed non-essential would not be working.

We would be remiss if we did not note the hardship that many of those workers, as well as recipients of social assistance, are going to face.

In addition, should the impasse go on long enough, it is likely that the federal government will run out of cash to fund the Supplemental Nutrition Assistance Program, or food stamps, which provides food security for roughly 40 million people.

Under more normal circumstances, the Financial Responsibility Act, which set levels of spending on defense and nondefense discretionary items, would serve as a baseline for the 12 annual appropriations bills or a continuing resolution.

But today, that is not happening, so it is appropriate to estimate the economic drag that a shutdown would cause. Nondefense discretionary spending accounts for roughly 3% of GDP.

Given the recent number of government shutdowns, we are confident that the economic impact will be modest and would push a small portion of economic activity into the first quarter.

While the shutdown would have an indirect impact as well, including a loss of consumer confidence, falling equity prices and stifled lending, it would occur at an inopportune time. The United Auto Workers strike, the restarting of student loan payments and the continuing impact of rising interest rates are all weighing on the economy.

That confluence of events would almost certainly cause GDP growth to ease back from 3% in the current quarter toward 1% in the final quarter should they linger into November or even December.

Any government shutdown will affect about 25% of all discretionary spending. Mandatory spending on Social Security, Medicare and Medicaid is not part of the annual appropriations process and will continue.

In contrast, defense spending is part of discretionary spending by Congress and would be affected by a shutdown.

Lastly, a shutdown would affect the government’s publishing of statistics on inflation and employment, which would create difficulties for the Federal Reserve in setting its policy rate should the impasse continue.

Given the political polarization and increasing fragmentation inside the GOP, we do not anticipate a near-term resolution on federal spending and expect the federal government will shut down for a number of weeks to kick off the final quarter of the year.