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Economic Monitor – Weekly Commentary
by Eugenio Alemán

Here we go again: Showdowns and shutdowns

September 29, 2023

While government shutdowns impact the economy directly and indirectly, the magnitude of the impact is determined by the length and scope of the shutdown. Some operations can continue in a “partial shutdown” scenario, and thus impact the economy differently. During a shutdown, the government temporarily pauses nonessential operations and furloughs nonessential federal workers and halts appropriations of what is called discretionary spending, which is about 27% of total federal expenditures. Meanwhile, mandatory spending like Social Security and Medicare will continue, as they do not require annual congressional approval. However, some of the services associated with the provision of these essential services could be affected if workers are furloughed.

GDP (Government Spending Component):

Over the past 3 years, government spending has represented about 6.6% of total GDP. Out of that 6.6%, about 2/3 goes to mandatory spending—according to the U.S. Treasury—which would be marginally impacted by the shutdown (e.g., Medicare, Social Security, etc.). The remaining 1/3 that goes to discretionary spending would be more impacted. Also of note, shutdowns don’t cancel spending but delay it. If the shutdown is short-lived, spending will catch up within the same quarter-reporting period and no subsequent measured effect will be felt on GDP.

Historical example from the Congressional Budget Office (CBO): The CBO estimated the GDP impact in 2019 to have been about -0.2 PP percentage points from the headline number (1Q19), but they also mentioned that this negative impact was made up for in subsequent quarters. (This government shutdown lasted about 1 month.)

Employment (Federal Employees):

To put things in perspective, federal employees make up, on average, ~2% of the total U.S. nonfarm payrolls. Even if the government does shut down, not all these workers will be impacted as ‘excepted’ workers will continue to contribute to the limited functions of the government. Those impacted will be ‘furloughed’ and not laid off, which is an important distinction since they will receive the pay back after the shutdown ends. Thus, their contribution to GDP may, in a worst-case scenario, be detracted from the current period but added back once the government reopens.

Perhaps the biggest issue for furloughed federal government employees will be dealing with the payments of debts, especially if they are living paycheck to paycheck.

Other Indirect Effects:

PCE: Personal Consumption could fall as government workers’ delayed paychecks would cause a temporary pullback in their personal spending.

Employment other than federal employment: Although federal government employees will go back to work once the shutdown is over, that will probably not be the case for workers in other industries that service the Federal government as suppliers as workers in retail businesses that provide services to those federal employees, especially in the Washington DC area. These disruptions are hard to measure and will also depend on the duration of the shutdown.

Investor sentiment: From process disruptions and deteriorating confidence in the government, different asset classes could be harmed. However, we expect that impact to be very limited and short- lived.

Credit Rating: As seen in news headlines, credit ratings such as Moody’s expect an impact on their U.S. ratings should Congress allow a government shutdown to take place. This could mean putting the U.S. debt in review for a downgrade and/or going ahead with the downgrade. The impact of such an event is very hard to measure because it could, potentially, severely affect investor confidence.

Federal Data Reporting Agencies: Federal agencies that report economic data including the Bureau of Labor Statistics, the Bureau of Economic Analysis, etc., will not release economic data during a shutdown. This would add several layers of uncertainty to the ‘data-dependent’ Federal Reserve as important economic indicators are used to determine its monetary guidance. In fact, in just over a month, the next FOMC meeting will take place, and members of the Fed will certainly be eager to look at what economic data such as inflation (10/12), employment (10/6), and other indicators have done since its last meeting in order to steer its monetary policies in the right direction.

Federal Reserve: Although it is too early to tell because we don’t know the length of the shutdown, the Federal Reserve will probably not increase the federal funds rate during its October/November Federal Open Market Committee meeting if the shutdown is still in place as it will try to not add more uncertainty to an already uncertain environment. Furthermore, if the shutdown remains in place well into December, the Federal Reserve will probably skip increasing interest rates during the last meeting of the year. Once “normalcy” is restored and data is once again available, the Fed will decide on the path going forward.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

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