The Shutdown and the Economy

October 1st, 2013 at 3:13 pm

Besides this newspaper account of negative multipliers in action, you’re probably hungering for more information on the economic impact of the shutdown.

–In terms of direct costs, which are lower than total costs (as you’ll see below), that of course depends on how long it lasts, but we’re likely talking single-digit billions.  The three-week shutdown in 1995-96 is thought to have cost around $2 billion in today’s dollars, and while no one knows how long the current episode of dysfunction lasts, I’d guess it’s less than three weeks.

–Part of the cost comes from retroactive pay for furloughed workers (i.e., paying for work that wasn’t done, and then had to be completed once folks were back on the job).  There are about 800,000 of such workers in this round, and here’s an important wrinkle: they cannot know for sure whether Congress will decide to pay them until the shutdown is over, i.e., until there’s a continuing resolution funding the agencies.

That means affected households are likely to rein in their spending, and while that number represents only 0.5% of the workforce, their reduced economic activity could be felt in communities where they are over-represented, like DC, or in small towns that host a popular national park (all such parks are closed).

BTW, non-furloughed government workers are also working for no pay while their agencies remain unfunded but they must be compensated once the shutdown ends.

–On that point about the parks, tourism takes a hit, as folks cancel trips to national parks or DC.

–Another less well-known impact comes through the lack of data.  For example, it looks like they’ll be no jobs report this Friday, despite the fact that the Bureau of Labor Statistics has already collected the data on jobs, unemployment, and earnings for last month.  That’s not an obvious first-order cost to the near-term economy, but it means market analysts and, importantly, the Federal Reserve, lacks an important input into their work.

–But the most important economic impact of the shutdown is one that could go either way: does the shutdown make default on the national debt more likely or less likely?  Because the economic impact of a default would be way, way, way worse than the shutdown.

If you think that the extremist wing of the Republican party will have been sated by shutting down the government, or, more realistically, if you believe that the moderate R’s will decide that it’s time to turn off the Cruz control and regain control of the vehicle, then you believe that the shutdown lowers the odds of default.

But if you think this just heightens their blood lust, and the moderates have lost, or ceded, control, then you believe the shutdown heightens the odds of default.

I’m in the former camp—I don’t think we’ll default.  But I’m not sure, and you simply can’t over-estimate the recklessness of the House R’s and the dyfunctionality of the current governing process.

Just for fun, and admittedly using made up numbers, let’s say there’s a 15% chance of default, and that this would raise the risk premium on government bonds of the average maturity by 75 basis points (0.75%).  The debt held by the public is now $12 trillion (that number is not made up).  That means my expected increase in debt service as a result of this dysfunction is $14 billion.  If you think there’s a 40% chance of default, you’re at $36 billion.

That’s real money.

–Finally, some private forecasters think a one-week shutdown would shave a few tenths of a percent of off real GDP growth in the current quarter.  Mark Zandi predicts that a long shutdown—3 to 4 weeks—could reduce growth by 1.4 percentage points in the quarter.  That sounds a little high to me, but who knows?

What we definitely do know beyond the shadow of a doubt is that any of these costs are way too high for a recovery that’s already fragile and a job market that’s already too weak.

I also haven’t even gotten into the human discomfort of cancelled Head Start slots, diminished senior and veteran services, and much more that would also start to become prevalent if this goes on for too long.  And that’s on top of the sequester.  This morning someone told me about a Head Start center that, because of sequester cuts, had to open late in the school year, i.e., yesterday.  Then, because of the intersection of that center’s funding cycle and the shutdown, it had to close today.

Our government at work, folks.  We very much need to get this shutdown and the debt ceiling behind us ASAP and do everything we can to get back to solving problems as opposed to creating them.

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6 comments in reply to "The Shutdown and the Economy"

  1. azlib says:

    What moderate R’s? So far they have gone along with this self-made disaster.

  2. Th says:

    Seems to me there is a sizable contingent of Republicans who have grown impatient with “starve the beast” and want to hasten the bankruptcy of the government with these manufactured crisis. That Obama’s legacy of economic recovery is damaged is just frosting.

  3. BigGuy says:


    I run a small hedge fund, went to Wharton, and am a CPA. Republicans in the House are acting like if the USA defaults, it may not be a problem. That’s possible, although not likely.

    The best case scenario is that nothing happens in the financial markets or in the economy because the default only lasts for a day or two and then is resolved. The market falls when the default is announced and then everything goes right back up the next day. No one gets hurt.

    The US dollar and short term US debt are the world’s reserve currency and where the world stores short term money. If the USA defaults on its debt, that means the holders of USA debt do not get paid. When everybody goes to sell their debt at once, the price falls and interest rates go way, way up. Higher interest rates mean that owning stocks and owning real estate are not as valuable so prices there fall too. The only thing that retains value for sure is cash, so everybody tries to get cash at once. Since everybody tries to get cash at once, hardly anybody does. Our economy can not handle a financial panic in which everyone wants to get cash at once.

    Here’s what I think is the most likely scenario, if the USA defaults on our debt, and only stays in default for five business days.

    USA financial markets will close on the the announcement of default immediately. They will not reopen the following day.

    One or two days later, the Nasdaq and NYSE open down one third — the Dow at 10,000. Residential real estate in the whole of the USA falls in value 5% the first day, and will be down 10% in value by the sixth business day after default. At least one of the major money center banks — BAC, C, JPM — fails and is taken over by the Fed. Nearly all the 401K pension plans in the country decline in value more than a third.

    Total financial wealth lost will be in excess of $6 trillion — $20,000 per capita.

    It could easily take more than FIVE YEARS to recover from losses created by Republicans in FIVE DAYS.

    Even if Republicans respond only a week into default, by giving Obama a carte blanche — allowing not only the debt limit to be increased, but also allowing a tax increase upon capital gains, dividends, and interest and aggressive fiscal stimulus putting 10+ million people to work for the federal gov’t — recovery could take decades. Prices would STAY DOWN for more than five years before returning to where they were.


    Within a year, the Dow Jones Industrial Average falls 80-90% — 1500 instead of 15,000 — and residential real estate falls between one-half and two-thirds. All of the major money center banks are nationalized. Goldman Sachs or Morgan Stanley or both fail. At least one of the largest life insurers — MONY, NY Life, Prudential, the Hartford — fails. The labor force participation rate declines from 63.5% to 40% — more than 40 million people become unemployed and leave the workforce. Total wealth lost would exceed double the GDP — about $30 trillion — $100,000 per capita. More than 90% of the population would NOT recover the wealth lost in the next 20 years.

    Three generations later, in 60 to 75 years, the economy recovers to where it was in 2007.

  4. purple says:

    Visa applications for immigrants are delayed, and the process for a green card can take up to a year already.

    People also depend on continuance visas from USCIS and if they are delayed it essentially means, for instance, that you could be overstaying your temporary visa even if you filed the paperwork on time.

    This is all incredibly stressful, as well complicated, and damages lives.

  5. Dave says:

    This is not our government at work. Bad characterization.

    This is our oligarchies at work.

    New marketing strategy: Got Freedom?

  6. Dave says:

    I assume you’ll be in Wichita on October 14.

    That is the day of the big march. We all have to be there. See you there.