What impact would a government shutdown have on the U.S. economy?

Weekly Comment
Wednesday, October 4, 2023

Each year, Congress must pass legislation to fund the federal government for the next fiscal year. A shutdown occurs if Congress is unable to pass the necessary spending bills, or a resolution providing interim funding before October 1, when the fiscal year begins. In this context, the Senate passed a last-minute spending bill, avoiding a government shutdown. This bill allows the government to remain open for 45 days (until November 17), giving Congress more time to complete this funding process in the midst of arduous negotiations. It is important to note that issues related to border security and aid to Ukraine were the two major points that delayed an agreement. Below, we share some of the economic implications of a potential government shutdown.

  • A shutdown would affect federal agencies that rely on discretionary spending.  Not all government spending would be affected by a shutdown. Congress passes annual funding bills to fund discretionary spending (defense programs, education, transportation, etc.). In total, these expenditures account for 25% to 30% of federal spending. Mandatory spending, such as Social Security, Medicare or interest payments, is regulated by other laws and would not be affected by a lack of appropriations. In addition, not all funding shortfalls affect the entire discretionary budget. During some previous shutdowns, Congress passed one or more of the 12 appropriations acts, limiting the scope of those shutdowns to only those agencies whose funding had expired.
  • A shutdown would primarily affect the economy through three channels. First, there would be a loss of productivity due to furloughed federal workers. When a government shutdown occurs, a portion of federal workers are furloughed, meaning they are temporarily not allowed to work, which affects the normal functioning of the government. Second, there would be a negative impact from delayed payments to businesses, contractors and employees. However, it is likely that any postponed spending would be realized once the government resumes operations, while delayed salaries would be retroactively compensated. Finally, a shutdown could disrupt the delivery of government services to the private sector such as: delays in permitting, licensing, federal loan processing, disruption in tourism (closures of museums, parks, monuments, etc.) and transportation.
  • In general, a government shutdown affects the economy to the extent that it is prolonged. In this regard, there have been 20 such episodes since 1976, with an average duration of eight days. The longest shutdown, which occurred in 2018-19, lasted for 34 days.

Are financial markets worried about government shutdowns? In reality, the historical average performance of the S&P 500 during government shutdowns has been slightly positive, averaging around 0.1%, which is virtually neutral. However, these are events that do have the potential to generate very short-term volatility. In the 2018-2019 government shutdown, the S&P 500 fell 2.7% on the first trading day after the shutdown, recovered nearly 5% on the next trading day, and was up over 10% by the end of the 34-day shutdown. Broadly speaking, investors view this as a temporary event, which translates into a modest impact to the economy. That said, the Congressional Budget Office estimated that the 2018-2019 shutdown cost the economy about US$3bn.

List of the longest government shutdowns in U.S. history

Note: start dates are the final dates of the budget authority, where funding shortfalls began the following day.

Source: morningstar, Charles Schwab y nytimes