With Congress struggling to pass funding legislation and budget appropriations set to expire on October 1, the federal government could face gridlock.
To date, Congress has not passed any of the twelve budget bills that make up the discretionary spending budget. The Senate passed a continuing resolution Tuesday that would temporarily fund the government through Nov. 19, but the fate of that legislation in the House is uncertain. DBRS Morningstar does not expect any immediate impact to the AAA credit rating of the United States. Still, a prolonged shutdown would increase headwinds for the economy and increase the likelihood of a recession.
A closure would disrupt federal agencies that rely on discretionary spending
Not all government spending would be affected by a shutdown. Congress passes annual appropriations bills to fund discretionary spending. Overall, these account for 25-30% of federal spending. Mandatory spending – such as Social Security, Medicare or interest payments – are governed by different laws, and these areas would not be affected by a loss of funds.
Furthermore, not all funding gaps impact the entire discretionary budget. During some previous closures, Congress passed one or more of the 12 appropriations bills, limiting the scope of those closures only to those agencies whose funding had lapsed. In this case, however, Congress has not passed any of the 12 bills, suggesting it could be a full shutdown rather than a partial one.
The economic costs of a shutdown would be small and temporary
A shutdown would primarily impact the economy through three channels. First, there is a loss of production due to furloughed federal employees. During the closures, most federal employees are considered “exempt” and therefore continue to work and contribute to economic activity. However, from a macroeconomic perspective, the number of furloughed workers can still be meaningful. During the full shutdown in 2013, approximately 850,000 workers were furloughed out of 2.1 million federal employees and a total economic workforce of 155 million. A similar dynamic could play out if a full shutdown begins next week, with lost output from furloughed workers likely to have a relatively negligible but direct impact on GDP.
Second, a shutdown could have a negative impact on the economy through late payments to companies, contractors and employees. Businesses could cease operations and workers could postpone purchases while they wait for the government to pay for their goods and services. However, these effects would likely be small and temporary. Any deferred spending would likely occur after the government reopens. Additionally, it is unlikely that federal employees will significantly reduce their consumption due to delayed paychecks since they will be entitled to repayments after the shutdown ends regardless of whether they were furloughed.
Third, a shutdown could impact the delivery of government services to the private sector. This can result in delays in federal loan approval, licensing, and processing. It could also disrupt the tourism and transportation sectors as passport and visa applications go unprocessed and national parks, museums and monuments potentially close to public access.
The costs of a shutdown increase the longer it lasts
Overall, a shutdown would disrupt the economy, but the damage would likely be minimal. However, the costs would increase the longer the shutdown lasts. There have been 20 government funding gaps since 1976, when the current budget framework was introduced. The average duration of a closure was eight days (although this also includes funding gaps prior to 1981 that did not result in a closure). The longest shutdown occurred in 2018/19 and lasted 35 days.
With the Republican Party holding a narrow majority in the House of Representatives and Democrats controlling the Senate, a bipartisan agreement is needed to keep the government open. Congress could act quickly to prevent a shutdown by passing the 12 appropriations through omnibus legislation and sending them to President Biden for his signature. Alternatively, congressional leaders could find a way to pass a permanent resolution to extend funding for a short period while negotiations over full-year appropriations continue. However, in this case the risk of a shutdown can only be delayed. Finding bipartisanship in today’s polarized political environment could take time.
A shutdown next week would come at a sensitive time for the United States. The economy continued to perform remarkably well in the summer months. Strong jobs and retail spending data in July and August suggest that overall GDP will likely reflect solid growth in the third quarter. However, a shutdown would add to the increasing headwinds the economy is already facing.
These headwinds include the resumption of federal student loan repayments, striking auto workers, and the delayed impact of restrictive monetary policy. Combined with these pressures, a prolonged shutdown would reinforce our expectations of a significant slowdown in growth over the next two to three quarters and increase the likelihood of a recession.
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