How much does a US government shutdown cost the economy?

As discussions in Washington over federal spending continue, the potential for a government shutdown is growing. A shutdown would probably have a modest effect on the economy, which may also make a sustained impasse over spending more likely, according to Goldman Sachs Research.

“Unlike the debt limit, where Congress reached a deal because the potential hit to the economy from an impasse would have been so severe, a shutdown would be much more manageable from a macroeconomic perspective,” Goldman Sachs Chief U.S. Political Economist Alec Phillips writes in the team’s report. “However, compared to the debt limit, the less severe economic effect of a shutdown also makes it more likely that Congress fails to act in time.”

A government-wide shutdown would directly reduce growth by around 0.15 percentage point for each week it lasted, or about 0.2 percentage point per week once private sector effects were included, and growth would rise by the same cumulative amount in the quarter following reopening, Phillips writes. While federal spending is equal to almost a quarter of gross domestic product, the impact of a shutdown is much smaller, for four reasons:

1. Only discretionary spending would be affected, about a quarter of federal outlays, because mandatory spending (on programs like Medicare and Social Security) runs automatically subject to rules Congress has established.

2. Only departments that Congress has not funded would shut down; while none of the dozen standard appropriations bills have passed to date, prolonged shutdowns have typically spared agencies such as the Department of Defense.

3. Shutdowns primarily affect the work of federal employees (federal pay amounts to roughly 2% of GDP), with little impact on investment or purchases of goods and services.

4. The majority of federal employees, roughly 65%, would continue working during a shutdown because the services they provide are likely to be deemed essential.

Markets have not reacted strongly to past shutdowns, according to Goldman Sachs Research. At the close of the three prolonged shutdowns since the early 1990s, equity markets finished flat or up even after dipping initially. The dollar weakened slightly after prior shutdowns began and the 10-year Treasury yield generally declined, but debt-limit concerns drove yields higher across the curve during the 2013 episode. “It is hard to draw firm conclusions and unrelated events occurring at the same time make comparisons difficult,” Phillips acknowledges.

Given modest economic and market effects, a shutdown should have little effect on Federal Reserve policy. If anything, a prolonged shutdown starting in October “might add incrementally” to the arguments that the rate-setting Federal Open Market Committee (FOMC) will stay on hold at its November meeting, Phillips writes, which the team already expects. A shutdown could also cause disruptions to the government’s economic releases, reducing visibility into the state of the economy. Still, the FOMC has tended to publicly downplay the importance of government shutdowns.

“Over the years, there have been many near misses and more false alarms than actual shutdowns,” Phillips writes. “That said, the ingredients for a shutdown — a thin House majority, a dispute on spending levels, and potential complications from various political issues — are present.”

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