What Impact Would a U.S. Government Shutdown Have on the Economy?

With the U.S. Congress struggling to pass funding bills and appropriations set to lapse on Oct. 1, the federal government could be headed for a shutdown.

So far, Congress has not enacted any of the 12 appropriations bills that make up the discretionary spending budget. The Senate passed a continuing resolution on Tuesday that would temporarily fund the government until Nov. 19, but that legislation faces an uncertain fate in the House of Representatives. DBRS Morningstar does not foresee any immediate credit implications for the United States’ AAA rating. Still, a prolonged shutdown would intensify headwinds for the economy, as well as the chances of a recession.

Not all government spending would be affected by a shutdown. Congress passes annual appropriations acts to fund discretionary spending. In total, these account for 25%-30% of federal expenditure. Mandatory spending—such as Social Security, Medicare, or interest payments—is governed by other laws, and these areas would not be affected by a lapse in appropriations.

A Shutdown Would Disrupt Federal Agencies That Rely on Discretionary Spending

Moreover, not all funding gaps affect the entire discretionary budget. During some previous shutdowns, Congress passed one or more of the 12 appropriations bills, limiting the scope of those shutdowns to just the agencies whose funding had lapsed. In this case, however, Congress has not passed any of the 12 bills, suggesting this could be a full rather than a partial shutdown.

Economic Costs of a Shutdown Would Be Modest - In the Short Term

A shutdown would primarily affect the economy through three channels. First, there is a loss of output due to furloughed federal workers. During shutdowns, a majority of federal workers are deemed “excepted” and therefore continue to work and contribute to economic activity. However, the number of furloughed workers can still be meaningful from a macro perspective. During the full shutdown in 2013, about 850,000 workers were furloughed out of 2.1 million federal employees and an economywide labour force of 155 million. A similar dynamic could materialize if a full shutdown commences next week, with the lost output from furloughed workers likely having a relatively negligible but direct impact on GDP.

Second, a shutdown could adversely affect the economy through delayed payments to firms, contractors, and employees. Businesses may pull back on operations and workers may postpone purchases as they wait for the government to pay for their goods and services. However, these effects would likely be small and temporary. Any postponed spending would likely take place once the government reopens. In addition, federal workers are unlikely to significantly reduce consumption due to delayed salary payments, as they are entitled to back pay once the shutdown ends, regardless of whether they were furloughed.

Third, a shutdown could disrupt the delivery of government services to the private sector. This could include delays in permitting, licensing, and processing federal loans. It could also disrupt the tourism and transport sectors, as passport and visa applications go unprocessed and national parks, museums, and monuments potentially close to the public.

Cost of Shutdown Increases the Longer It Lasts

Overall, a shutdown would disrupt the economy, but the damage would likely be minimal. That said, the cost would increase the longer the shutdown lasts. There have been 20 government funding gaps since 1976, which was when the current budgetary framework was put in place. The average length of a shutdown has been eight days (although this includes funding gaps prior to 1981 that did not lead to a shutdown). The longest shutdown was in 2018-19 and lasted 35 days.

With the Republican Party holding a narrow majority in the House and the Democrats controlling the Senate, a bipartisan agreement is needed to keep the government open. Congress could act quickly to avoid a shutdown by passing the 12 appropriations through omnibus legislation and sending it to President Joe Biden for his signature. Alternatively, congressional leaders may find a way to pass a continuing resolution to extend funding for a short period while negotiations over full-year appropriations continue. However, in that case, the risk of a shutdown may merely be postponed. Finding bipartisanship in today’s polarized political environment could take time.

A shutdown next week would come at a delicate moment for the U.S. The economy continued to perform remarkably well through the summer months. The strength of jobs and retail spending data in July and August suggest headline GDP will likely reflect solid growth in the third quarter. However, a shutdown would add to the mounting headwinds already facing the economy.

These headwinds include the resumption of federal student loan repayments, striking auto workers, and the lagged effects of tight monetary policy. Combined with these pressures, a prolonged shutdown would reinforce our expectations of a marked deceleration in growth over the next two or three quarters and increase the odds of a recession.