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Economic Fundamentals Unaffected by Shutdown

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Economic Fundamentals Unaffected by Shutdown

January 21, 2018

The failure of Congress to approve yet another stop-gap budget has resulted in a temporary “government shutdown” as of this writing. To the casual observer, a government shutdown sounds ominous indeed. But in reality, its short-term effects are minimal, and its longer-run effects are nil. 

The temporary shutdown—which is not really a shutdown in any sense of the word—reflects the inability of Congress to deal forthrightly with the budget issues it faces, and its willingness to be tied in knots by its arcane and virtually impossible-to-understand budget rules.  It adds to the lack of credibility of the Congress, but not much else.

Such temporary shutdowns have occurred numerous times in the past—most recently, in 2013—and close observation suggests that they have little effect on trends in economic conditions, interest rates, the stock market, or even the dollar.  The shutdown also has little effect on the wide array of government operations.  

Rather than enact a budget before a fiscal year begins, congressional squabbling and Congress’s willingness to bend an increasingly complex and dysfunctional array of budgeting rules results in approvals of temporary budgetary extensions that provide government funding through a set period of time.  The latest extension expired midnight on Friday, January 19.  Without voting to extend funding, the government shuts down.  But it is not really a shutdown.  In reality, it affects very little.

“Entitlement programs” such as Social Security, Medicare, Medicaid and other such programs for which funding is automatically available without Congress's annual budget approval, continue unaffected.  The government's disbursements for these programs, which comprise the large majority of government spending, will continue.  

In contrast, the government's “discretionary programs” such as defense and national security (including the Office for Homeland Security), education (the vast majority of education funding is provided at the state and local levels), transportation, commerce and other programs and general government operations require that the Congress must vote to appropriate funds each fiscal year.  In principle, these programs are affected in a shutdown.  

However, the Federal government has so much experience in dealing with shutdown-related disruptions that it has created an evolving set of procedures—with flexibility and exemptions—such that the vast majority of government functions will continue to operate during a temporary shutdown. 

There will be no effect on national debt service.  The Treasury will continue functioning. The Federal Reserve will remain in business.  Virtually all defense and national security functions will operate smoothly.  The Environmental Protection Agency will remain open (relying on “unused funds”) and the National Parks will remain open.  President Trump has flexibility to carry out his constitutional duties—including going to the World Forum's policy boondoggle in Davos—and Secretary of Defense Mattis has flexibility to go on his planned trip to Asia. Air traffic control employees are considered essential government workers and the air traffic control system will continue to operate.

About two million federal government workers are considered "essential," including all active military personnel, and will continue working. Members of Congress by law must continue to be paid. Who will be affected?   While most government employees will get a paid vacation, about 800,000 who are deemed “non-essential” may be furloughed. Following previous shutdowns, such as the one in 2013, Congress has passed legislation that reimburses furloughed workers for back pay.  Payments to some government contractors may be delayed.  Some government services may temporarily be trimmed or delayed.

If a government shutdown has effects that are so minor—and so closely managed—why do the government and Congress “agree” to a temporary shutdown?  It is all about politics and the efforts of the political parties to get their way on specific legislation—both budgetary and loosely related to the budget—and to make the opposing political party look bad. 

The midterm elections in November loom, and already dominate Washington DC.   Among leading battles, Republicans want to ensure funding for higher defense caps for defense and military readiness.  Democrats want to shield from deportation immigrant children brought into the United States, and more broadly, press for immigration reform.

This temporary government shutdown reflects the state of dysfunction in the budgetary process and the warring and divided Congress.  In opinion polls, public approval of Congress is abysmally low; no wonder.  Again, this is only one in a series of government shutdowns in history.  Unfortunately, threats of government shutdowns have become relied-upon tools in fiscal and political battles in Washington DC, and it is hard to see an end to this practice.

In this highly-charged political environment, US economic and financial performance remain healthy.  The positive fundamentals will not be materially affected by the current political dysfunction. 

Mickey Levy is the chief economist for the Americas and Asia of Berenberg Capital Markets, LLC, and member, Shadow Open Market Committee. 

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