What are the impacts of a potential temporary government shutdown on the US government?

The current negotiations for the fiscal year 2024 budget in the United States have reached a stalemate, increasing the likelihood that no consensus will be reached before October 1st. According to US law, Congress must pass the budget for fiscal year 2024 (October 2023-September 2024) before October 1st. Otherwise, there is a risk of temporary government shutdown, and agencies that do not receive funding will cease operations until either 1) all parties reach an agreement or 2) a short-term financing bill (Continuing Resolution) is passed to temporarily fund the government until the budget is passed by Congress.

Recently, some right-wing Republicans have demanded an 8% (US$0.12 trillion) reduction in spending for fiscal year 2024 to US$1.5 trillion (~5.8% of GDP in 2022). With the deadline approaching on October 1st and significant differences between the two parties regarding the passage of a short-term financing bill, the risk of temporary government shutdown has increased. It is worth noting that under any circumstances, expenditures such as interest payments on national debt and mandatory spending will not be affected.

A government shutdown can drag down growth in the short term, with an average of about 0.1 percentage point decrease in GDP growth per week of shutdown. The impact of a government shutdown on GDP mainly includes two channels: a decrease in government spending due to unpaid government employees and a suspension of government purchases of goods and services, which drags down GDP. However, most of the GDP losses will recover in subsequent quarters after reopening. According to CBO calculations, the quarter-on-quarter annualized drag on GDP due to a five-week government shutdown in 2018 was 0.6 percentage points; while CEA calculations showed that a two-week government shutdown in 2013 dragged down GDP by 0.25 percentage points and employment fell by 120,000. Therefore, on average, a one-week shutdown reduces GDP growth by about 0.1 percentage point.

A government shutdown can also affect the collection and release of important data, which may affect the Fed's decision on raising interest rates in November. A BLS spokesperson has already said that a government shutdown will affect data collection and compilation, and data can only be restarted after government funding is restored. Activities of BEA and Census Bureau, both of which belong to the Department of Commerce, may also be affected. This means that if the government shutdown lasts too long, important data such as non-farm payrolls in September, CPI in September, and GDP in the third quarter may be delayed (see chart 11). This is different from 2018-2019, when the government shutdown but NFP and CPI were still released on time as BLS continued to receive funding. When the FOMC meeting convened by the Fed is held on November 2nd Beijing time, committee members may make decisions without timely viewing key economic data such as non-farm payrolls, inflation, and GDP. As the Fed has repeatedly emphasized its reliance on data for decision-making, missing key economic data may cause the Fed to skip raising interest rates again.

Historically, the impact of government shutdowns on the stock market, bond market, and the U.S. dollar has varied. Looking at the performance of the stock market, during more than 20 government shutdown periods since 1976, the S&P 500 index fell 9 times (43%) and rose 12 times (57%), with an average increase of 0.3% (Chart 12). Looking at the performance of U.S. bonds, 2-year and 10-year Treasury yields performed inconsistently during government shutdown periods, but overall, 2-year Treasury yields fell slightly on the day of shutdown (Charts 13 and 14). Looking at the performance of the US dollar, during government shutdowns, the US dollar index typically falls by an average of 0.3% (Chart 15).

As the recent discussion on US fiscal sustainability heats up and US bond yields become an important source of market volatility, the government shutdown may intensify market volatility and push up US bond spreads. On September 25th, Moody's stated that although a short-term shutdown will not affect debt payments or the economy, it highlights the relative fragility of US institutions and governance compared to other AAA-rated countries; a government shutdown could affect US ratings. As Moody's is the only rating agency among the three major agencies that gives the US a AAA sovereign rating, if Moody's downgrades the rating, the US will lose its AAA rating or push up US bond spreads.

After a brief (about two weeks) period of bargaining and partial departmental shutdowns, the fiscal year 2024 budget will eventually be passed. However, due to the likely twists and turns in the negotiation process from now until the end of this year, there is a risk of one or even two short-term government shutdowns.

In an optimistic scenario, Congress will pass a short-term financing bill before October 1st to avoid a shutdown fate, but considering that the Republican short-term financing plan lasts for 4-6 weeks, it is not ruled out that the expiration of the Thanksgiving short-term financing bill may bring pressure on the government to temporarily shut down again.