As the political impasse and blame game drag into Day 3 of the US government shutdown, economists and policymakers are assessing the potential impact on the economy. Please find below what I believe are the four major consequences if this situation were to prevail for more than a few days:
1. Impact on Aggregate Demand: The GDP Drag
With hundreds of thousands of Federal employees on furlough (and nearly a million affected in total according to some media reports), the immediate economic impact is a potential reduction in disposable income. Furloughed workers, facing delayed paychecks, may pull back on spending for now. This income shock, which would disproportionately affect lower-income households, can create a drag on overall consumer demand. Simultaneously, government spending on non-essential services, contracts, and grants slows to a trickle. Having said that, see the Congressional qualification that follows in point 2.
2. Fiscal Position: More Ambiguous than Many Think
The fiscal effect of a shutdown is often characterized as a government spending cut. In reality, the financial impact is generally ambiguous as the collection of tax revenue can also slow. Crucially, the effects are often only deferred, as Congress typically approves back pay once the government reopens (subject to another qualification — in point 4 below).
3. Loss of Economic Visibility: The Data Void
Economic indicators, such as today’s monthly jobs report (non-farm payrolls) and key agency surveys and data collections, are suspended. This data vacuum limits the information that economists and policymakers have to gauge the economy’s health. For a Federal Reserve that has consistently prided itself on being “data dependent,” this shutdown occurs at a time of potential inflection, forcing the Fed to operate with more limited visibility. The next crucial release, the Consumer Price Index (CPI) report, is currently scheduled for October 15th.
4. Risk of Permanent Downsizing
While furloughs are generally temporary, the political debate leading up to this government shutdown raised the specter of a permanent downsizing of government employment, or what some have called DOGE 2.0. To the extent that such permanent layoffs materialize, it would prolong the effects on income and consumer spending mentioned above. This would transform what is typically an immediately reversible shock into a more persistent short-term headwind for the US economy.
