The country appears to be stumbling toward a government shutdown as the authorization for funding runs out starting October 1. This would be the 22nd government shutdown since 1976, so one can take a look at the historical implications. While shutdowns can cause disruptions, the impact on the economy and markets has been modest in the past, with most economic activity delayed but not lost. And historically markets have been driven by the broader economic and earnings environment, not the temporary shutdowns.
The effect on the economy depends on how long any shutdown would last. The longer the shutdown, the greater the cumulative impact. The length of shutdowns has varied widely, with several lasting just a day and the longest lasting 35 days. The average is about a week.
Economists estimate a government shutdown would lower gross domestic product (GDP), a broad measure of the economy, by about 0.2% of annualized quarterly growth per week that the shutdown lasts. That’s a relatively moderate impact. For perspective, the latest estimate of second quarter GDP shows the economy grew at a 2.1% annualized rate. About half of the impact to annualized economic growth, however, would reverse once the shutdown ends as spending resumes and catches up.
Shutdowns impact the economy in a few ways. There are about 2.2 million federal employees who would not be paid during the shutdown. However, the federal workers always have been paid retroactively after a shutdown ends. Also, payments to government contractors would be delayed but ultimately resumed. The key here is that if spending drops when employees or contractors are not paid, it’s largely delayed and not lost economic activity.
Part of the impact of a shutdown, however, results in a permanent economic loss, largely from the lost output of government employees not working, and knock-on impacts on the private sector. Around 800,000 to 900,000 federal employees likely would be furloughed and not work. Some government employees, however, would continue to work as they are considered essential, such as the military, food safety inspectors, air traffic controllers and others. Also, it’s important to note that Social Security, Medicaid and Medicare are considered mandatory spending and are funded.
A shutdown, however, would come at a time when there are other moderate economic headwinds, including higher interest rates, rising oil prices, a broadening strike by auto workers and the resumption of student loan payments. It’s also possible an extended shutdown could dent consumer and business confidence.
Additionally, Moody’s rating agency may lower its rating of U.S. government from its top Aaa rating, following Fitch’s downgrade earlier this year and S&P’s downgrade in 2011. The market expects the downgrade, and Fitch’s downgrade earlier this year had minimal market impact.