How Badly Will the Shutdown Hurt the U.S. Economy?

It'll hurt. But the debt ceiling could be the real disaster

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Correction appended: Oct. 1, 2013

Without a deal between Congress and President to fund the federal government, dozens of federal agencies have shuttered their doors and hundreds of thousands of federal workers have been sent home or are being asked to work without pay.

But what are the overall economic effects of a government shutdown? After all, government spending makes up roughly one-fifth of GDP, so a shutdown of the federal government would presumably deal a big blow to the economy as a whole. Many economists are studying previous shutdowns to predict how the current standoff will influence the economy going forward.

“Government shutdowns have been surprisingly common since 1976,” writes Guy LeBas, chief fixed-income strategist for Janney Capital Markets, in a note to clients. He points out that the current shutdown is actually the 18th such occurrence since 1976. The vast majority of standoffs, however, have lasted just a few days. Given the apparent distance between Democrats’ and Republicans’ positions, analysts have been using the most recent 1995–96 shutdown (which lasted a total of 26 days) as a yardstick against which to analyze the current situation.

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LeBas estimates that if the 2013 shutdown lasts a similarly long time, it could shave 0.8% from economic growth in the current quarter. The effects would become more severe the longer the shutdown lasts. This reduction in economic growth would come primarily from roughly 800,000 federal workers being put on furlough and left without paychecks to spend. But as analysts at Macroeconomic Advisers point out, the long-term effect on the economy will have as much to do with how the budget impasse is resolved as how long it lasts. They predict that a two-week government shutdown will shave 0.3% from economic growth, but that the effect will be reversed in the following quarter if the government ends up instituting back pay for workers who were furloughed, as it did in last time.

In other words, the overall impact of a government shutdown on the economy will be muted, as long as Democrats and Republicans are able to come to an agreement relatively quickly. But that doesn’t mean that the economy will walk away from this showdown unscathed. “The real economic cost, which is extremely hard to measure, comes from heightened uncertainty,” writes LeBas. “Greater uncertainty will create hesitancy on the part of businesses to embark on new projects, and encourage consumers … to save rather than spend.”

Economists believe that the greater threat to the U.S. going forward would be Congress’ failure to raise the debt ceiling, an impasse the Treasury Department predicts the government will reach sometime in the middle of October. Congress has both the ability to decide upon the total amount of federal spending as well as the total amount of debt the government can incur. Every so often, however, a current Congress disagrees with the amount of spending approved by previous Congresses, setting the stage for U.S. to owe more money than a current Congress is willing to issue debt for.

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If Congress does not approve the issuance of new Treasury debt, that would put into question whether Congress is able to issue Social Security payments in full, make full-interest payments on its outstanding debt, or honor any number of other financial commitments the federal government is responsible for. LeBas writes that “if the debt ceiling is not raised by that point the consequences are admittedly hard to envision.”

Much of the global financial system relies on Treasury Debt and the U.S. dollar as the currency with which it does business, and any event that could put the trustworthiness of that debt into question could have broadly destabilizing effects. And unlike government shutdowns, there is no recent history from which to draw conclusions. The U.S. has never defaulted on its debt before, and therefore it’s difficult for economists and market watchers to predict what would happen if it does later this month.

Because of an editing error, an earlier version of this article misattributed a statement about the shutdown’s effects on the economy. It was analysts at Macroeconomic Advisers who made the assessment, not Mark Zandi, who is chief economist at Moody’s Analytics.