The Government Shutdown: Economic Implications and How it Relates to the Debt Ceiling
The longest government shutdown in history is already having a significant impact on the economy. Equally important, but less well understood, is the potential impact on negotiations over the March 1 deadline to raise the U.S. debt ceiling. As President Trump has continued to insist on a $5.7 billion allocation towards construction of a border wall between Mexico and the U.S., Democrats have been just as unrelenting in their opposition. It’s the same kind of political brinksmanship that played out repeatedly in past debt-ceiling negotiations. And if the current standoff over the shutdown continues, we may roll directly into yet another political crisis over the debt ceiling before we know it.
Economic Impact of the Shutdown
The economic consequences of the shutdown will be dependent on the duration of the stalemate. While previous shutdowns have had a limited impact on aggregate economic activity, none have lasted this long. But already, there have been multiple consequences for the U.S. economy. The White House itself estimated that economic growth has fallen by a little more than one tenth of a percentage point each week that the shutdown has lasted. The impact is expected to stem from lower consumption by furloughed and unpaid workers, the effect on government contractors, and delayed business investments due to policy uncertainty.
Nine of fifteen government agencies have been closed with 800,000 employees affected, of which 380,000 workers are on furlough and another 420,000 are working without pay. Jobless claims are expected to rise, having already increased by more than 9,000 in the last two weeks’ jobless claims report.
Following the 16-day long government shutdown in 2013, The Council of Economic Advisors released a report that described the ways in which U.S. business activity was affected in both direct and indirect ways: “The travel industry was hurt by the closing of national parks, businesses in oil and gas and other industries were hurt by the cessation of permits for oil and gas drilling, the housing industry was hurt by the cessation of IRS verifications for mortgage applications, and small businesses were hurt by the shutdown of Small Business Administration loan guarantees.”
In addition to the economic consequences, the shutdown has also hindered access to economic data. Federal Reserve Chairman Jerome Powell noted that the Fed’s ability to monitor the economy has been limited. While the Department of Labor still reports jobs and inflation data such as CPI, the closed Department of Commerce will not report on retail sales, GDP, durable goods, construction spending, new home sales and other economic indicators. This information is particularly important given slowing economic growth and the impact of recent volatility in stock and bond markets.
What the Shutdown Could Mean for the Debt Ceiling
Of even greater concern is how the inability of the House and Senate to work together might affect the upcoming expiration of the debt ceiling suspension. Last February, President Trump signed a bill suspending the debt ceiling until March 1, 2019, allowing the U.S. Treasury to borrow whatever amounts necessary to fund the government’s obligations on time.
On March 1, Congress will again be expected to either raise the debt ceiling to cap the amount to be borrowed for the new year or suspend the ceiling as has been done for the last five years. But given the inability of the two houses of Congress to reach consensus on a new budget before a government shutdown, there is a real possibility that they will be just as indecisive about whether to raise the debt ceiling. Such a stalemate could have serious consequences for the country.
When the debt ceiling is reached, the Treasury cannot issue new notes and can only rely on incoming revenue to fund government expenses. In this scenario, the government would need to decide what expenses to pay and what to delay or pass over. These expenses include, but are not limited to, employee salaries, social security benefits, and interest on the national debt.
Beyond the obvious downsides to withholding employee salaries or social security benefits, a default on the national debt could have other serious repercussions. Currently, the public debt is $16.9 trillion, owed to individuals, businesses, and foreign central banks. If foreign lenders become concerned that the U.S. will default, they may require higher interest rates in exchange for higher levels of risk. At the same time, the uncertainty of debt repayment may cause demand for U.S. Treasuries to decrease, putting even more upward pressure on the interest rates.
If the immediate consequences are not warning enough, Fitch’s global head of sovereign ratings recently said, “If this shutdown continues to March 1 and the debt ceiling becomes a problem several months later, we may need to start thinking about the policy framework, the inability to pass a budget…and whether all of that is consistent with triple-A.”
To Avoid a Debt-Ceiling Crisis, Break the Political Gridlock
When the debt ceiling is reached, Congress often uses “extraordinary measures” permitted by the Treasury Department to avoid defaulting on debt. In the past, these measures have included prematurely redeeming Treasury bonds in federal employee retirement savings accounts (and refunding them with interest later), pausing contributions to government pension funds, and suspending state and local government series securities. So, if the debt ceiling is not raised by March 1, the default would not occur until all extraordinary measures are exhausted.
But at that point, the debt ceiling would need to be raised to avoid default. Whatever Congress decides regarding the debt ceiling, it will need to act quickly and decisively in order to minimize concern and the consequences of an impasse. It will be up to Congress and President Trump to break the political gridlock and act as a united front in order to ensure a strong U.S. economy and minimize as much of the economic damage as possible.