10/1/13 – Assessing the Shutdown Damage

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Oct 1, 2013 11:17:17 AM

and tagged Fiscal Cliff, Politics and the Economy

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For the first time since 1995–1996, the U.S. government has been shut down in a dispute over the federal budget. Now that it has happened, we can start to assess the damage, as well as evaluate how the dispute is likely to play out.

Before we do, there are a couple of important things to keep in mind. First, we made it through the 1995–1996 shutdown, and we will make it through this one. Second, although there will be damage, it will be limited. Just as with the sequester spending cuts, the damage will be absorbed and the economy will return to growth. This too will pass.

The people most affected will be employees of the federal government or government contractors, who may be furloughed or have to work on an unpaid basis. For the average person, the shutdown will affect the services available. National parks and museums, for example, will be shut down, but the personnel who send out social security and other benefit checks will remain on the job, and the checks will continue.

The direct damage to the economy will take the form of reduced spending and reduced economic growth. Federal workers will not be paid, with more than 800,000 nonessential employees furloughed and the remainder continuing to work on an unpaid basis. Federal spending on nonessential programs will be curtailed. While it’s close to impossible to get very specific, we can make some rough estimates. Given the current federal budget, if the government were to shut down entirely, it would cost the economy about 0.5 percent of GDP per week. Much of the government will continue to function, however, so the damage won’t be that bad. A range of 0.2 percent to 0.3 percent of GDP per week of shutdown seems reasonable and is in line with other estimates of the damage: 0.9 percent of GDP for a three-week shutdown, per Goldman Sachs, and 0.2 percent of GDP per week according to IHS, an economics consultancy.

For comparison’s sake, the sequester spending cuts appear to have dampened economic growth by about 1.5 percent of GDP on an annual basis. A monthlong shutdown would get us into the same range of economic damage. Not good, certainly, but survivable. And if the shutdown were shorter than that, the damage to the economy as a whole would be proportionately less.

The more significant effects, and risks, of the shutdown will be indirect. The two biggest are the increase in uncertainty, which could reduce both consumer and business spending, and the impact on the debt ceiling negotiations. The debt ceiling negotiations will be considerably more important than the shutdown—and the fact is that the shutdown will make them more difficult.

The shutdown, combined with the pending debt ceiling negotiations, will make everyone more uncertain about the future. Uncertainty is bad for the stock market—the last time we got close to a debt ceiling showdown, the market took a serious hit—and for the economy. The last time we saw similar fiscal uncertainty was with the fiscal cliff at the end of last year, when economic growth came to a stop.

At this point, there’s no need to panic, as the damage is likely to be minimal and contained. As the standoff over government funding continues, however—and as we get closer to the much harsher spending cuts that will ensue if the debt ceiling negotiations fail—the stakes rise exponentially. We will be watching the situation carefully and provide further updates as warranted.

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