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The Consequences of the Government Shutdown

Professor Jonathan Parker

While the press are still celebrating the end of the government shutdown and deconstructing the political fallout, I was on a lunch panel yesterday sponsored by the Center for Finance and Policy here at Sloan on “The U.S. Fiscal Crisis: Causes and Consequences.”  My esteemed colleagues talked about the long run fiscal imbalances, the rise of the dollar and U.S. Treasury debt as reserve assets, and the thorny legal issues facing the Administration as money ran out.   I talked about the consequences of the shutdown, with a focus first on the real economy and then on financial issues.

In this first post on the topic, I want to argue that the direct effects of the shutdown on U.S. economy were small, or at least small relative to the media storm the shutdown created and relative to the collapse in consumer confidence that has coincided with the shutdown.  A reasonable estimate is that the shutdown cost in the ballpark of 25 billion dollars.  I do not mean to imply that billions of dollars are unimportant.  Look after your billions and your trillions will take care of themselves.  And the process can be excoriated for burning resources while accomplishing very little.  But this amount is small relative to the long-term fiscal imbalances in the background of the shutdown and relative to the costs that the U.S. government flirted with.  In my next blog post I will talk about the financial issues and risks.

But for this post, how do we want to think about or measure the direct effects of the government shutdown on the real economy?  There are several sources of costs.  Most immediately, we measure national output, GDP, as the sum of all goods and services produced during a quarter or a year.  We measure the contribution of each good or service at its market value.  New cars, for example, each contribute to GDP at the price at which they are sold. And you can see issues with such a measure.  Cars of the same exact make, model, and features contribute different amounts to GDP if they are sold to different people at different prices. Another example, no matter how much you would have paid to read this blog post, it contributes nothing (directly) to measured GDP because it is free to view and read (my writing this does not change my salary, nor does MIT produce more in any measured way from any additional web hits).  These measurement issues are even harder for the government.  How should we value a road?  How about the administrative work done at the IRS?  There are no market prices to observe.  And people’s opinions differ on the value of these goods and services.  So, we tie our hands to a simple accounting rule.  When the government spends money, provides services, does administration, etc. the contribution to GDP is the cost to the government.

During the shutdown, the government stopped paying about 800,000 workers, as well as a smaller number of contract workers, and actual contracts to purchase goods and services.  Thus, there will be a reduction in measured GDP, not unlike that cause by labor strife.  The shutdown was like a lockout by the nation’s biggest employer.

But, this reduction in government spending is already being offset by back-payment for many government workers as well as higher payments in the near future due to needing to catch up on the work not done during the shutdown.  While creating variable rather than smooth production, and some inefficiency, the direct effect of the shutdown is small.

There is the possibility of secondary effects. As furloughed workers stop spending, business that they would have bought from stop hiring, investment on goods that they would have bought is postponed, and so forth.  Historically, we know there is a rapid and substantial pass through from take-home pay to consumer spending.  But in this case, these effects should be very small.  Not only is the income reduction for government workers temporary, full salary payments are being made after only a short delay.  And the fact that incomes for the year may even be higher due to the need to make up lost time implies that there may even be slightly higher demand from government workers.

The Federal government does not only buy goods and services, it makes monetary transfers through insurance programs for health, employment and disability, and pension programs and finally debt payments – we will return to debt payments, but for now I want to emphasize that had the government cut these programs, this would have led to more substantial declines in consumer demand because these programs are much bigger.  However, in this crisis these payments were almost entirely uninterrupted.

Finally, the government collects taxes and fees which raise revenue, it grants licenses and regulates activity, and the shutdown jeopardized a  lot of economic activity. But essential employees were not furloughed, licenses were only delayed, and the fees are not a major source of revenue for the Federal government.  In the future, the government will have to spend less or tax more both to cover the lost revenues during the shutdown and to cover the higher payments for workers needed to catch up on missed work.

Standard & Poor’s provided one estimate of the costs of the shutdown: $24 billion.  This estimate seems large to me.  But even 24 billion amounts to about one half of a percent of GDP in the fourth quarter of 2013, or about one eighth of a percent of GDP in 2013, which is within the range of statistical uncertainty with which we measure annual GDP.  That is, the effect of the government shutdown of 2013 is likely statistically un-measurable in annual data.

Now all these costs would have been larger if the shutdown had been more prolonged, and they may arise again, and this risk of another shutdown creates uncertainty for people and businesses, and all of this is bad for the economy.  And the shutdown that actually happened was a waste. But it just wasn’t that costly in the context of the issues at hand.  So this raises our first puzzle, what happened to consumer confidence?

The below Figure comes from Gallop, and shows their measure of consumer confidence plotted over time.  Confidence is lowest during the Great Recession, picking up just before the end of the recession and trending upward until the sudden recent decline.  There is also a decline and trough in the middle of 2011, which happens to coincide with the fight over the debt ceiling that temporarily closed the government in the summer of 2011.  So it appears that households are very concerned about government shutdown – showing almost Great Recession levels of concern.

Maybe this is because of what happens in financial markets?  This is the topic of my next blog post . . . .

 Jonathan A. Parker is the International Programs Professor in Management and a Professor of Finance at the MIT Sloan School of Management.