We are getting close to the decision point on whether large parts of the government will shut down again because Congress has not passed a budget. While the Senate has come up with a plan, the House has not even been able to start considering one, which means the government will lack funding and will largely shut down, as of October 1. Given the dysfunction in Washington DC, at this point that shutdown looks likely, which means we must think through the consequences.
The good news is that, in the short term, the consequences—for the national economy at least—will be relatively minor. The bad news is that, because this is a different kind of shutdown than we have seen before, we can’t be certain how long it will last. And the consequences will mount over time.
A Different Kind of Shutdown
The reason it is a different kind of shutdown is because it is neither between the two parties nor driven by a specific issue. Historically, debates between the parties over the debt ceiling have driven shutdowns. And when an agreement was reached there? The shutdown was over. This time, the disagreement is not over a specific issue between the two parties but, instead, within the Republican Party on a range of issues.
With a group of Republican congresspeople holding out against initiatives supported by their leadership and refusing to allow regular business in the House, any path forward would require unity within the Republican Party, even before we consider the Democrats. As such, this is a much more fluid situation politically than we have seen before and, therefore, potentially harder to solve.
That said, this situation also has a clearer exit path if the majority of Republicans abandon the holdouts and cut a deal directly with the Democrats. This is both easy to imagine and, politically, very hard to do. So, this shutdown is both politically more complicated and potentially easier to resolve. As usual, it is all about politics—we just have another layer in place. So, we may have a longer shutdown, or it may be quite short. We just don’t know at this point.
The Economic Perspective
What does this all mean from an economic perspective? Nothing good. As we have seen before, the damage will likely be limited in the short term, but it could add up over time. Here is what we will be watching.
Job growth. With federal employees largely furloughed, this will hit both employment and purchasing power. This will be a drag on growth, especially as job growth has been slowing anyway. It will also hit consumer spending directly, through lower wage growth. Overall, this will be one more headwind in an already slowing economy.
Consumer confidence. Consumer confidence will also weaken with the job market. Confidence has already dropped over the past couple of months, and a shutdown could hurt confidence and spending. As gas prices remain high and interest rates continue to bite, this is one indicator that could start to move toward recessionary territory.
Interest rates. The U.S. government’s credit rating was partially downgraded in the last shutdown. We could see more downgrades, which could push interest rates higher. With the Fed already having taken long-term rates to the highest level since 2007, even higher rates would be another headwind—and one that could last beyond the shutdown itself.
Stock market valuations. More significant for investors, both lower consumer confidence and higher interest rates have been strongly correlated with stock market valuations. With both already moving in the wrong direction, any further negative impetus from a shutdown could make an already weak situation worse.
Just a Blip?
The first thing to watch for will be the shutdown itself: when it starts and how the politicians respond. As an economist and an investor, though, the next thing to watch will be confidence and interest rates. While the direct economic damage will be real, it will also be relatively minor. What matters more will be the indirect consequences both to the economy as a whole and to our investments. If Congress can get its act together, this will be a blip. But if Congress can’t, then the risks to our investments will rise materially.