Last week, I had the privilege of speaking at a conference in Stockholm. Economists from the United Kingdom, Italy, Spain, Germany and France were also on the program.
After we had all given our individual presentations, we were invited back up en masse to answer questions. So in that company, who do you think got the most questions about government instability? Thats right it was me. With Italys government toppling, Germanys unformed and Spains in crisis, the United States has apparently risen to the top of an ignominious list.
Congress failed to strike a compromise and fund the American government for fiscal year 2014, starting today, October 1. This is certainly not the first such event on record; 17 shutdowns have occurred prior to the latest episode. The 1995-1996 federal government shutdowns were the most protracted, consisting of two episodes totaling 26 days.
Here is a summary of our views on the situation.
Following are some questions and answers regarding the current situation.
Do we know how the shutdown will affect economic activity?
Annualized real federal government outlays accounted for about $1.2 trillion in a nearly $16 trillion economy in the second quarter of 2013. The impact of the shutdown is not uniform across all federal government agencies. For example, air traffic controllers, border security personnel, food inspectors and other essential services will not be affected.
Lost wages of furloughed employees and associated ripple effects will bear on economic activity. The impact can vary from a few tenths of headline real gross domestic product growth to something more significant, depending on the duration of the shutdown. In the 1995-96 episode, Congress restored lost pay, which ended up neutralizing the short-term impact.
And on a side note for the economy, a wide range of economic data (including this Fridays always-influential employment data) may not be provided on schedule, or at all.
What is different from 1995-96 experience?
The U.S. economy is growing at a muted pace, compared with the strong momentum of 1995. So there is a feeling that the expansion is quite a bit more fragile. In hindsight, the Federal Reserves September decision to maintain the current asset purchase program looks better in the current light.
More importantly, the standoff in 1996 did not roll over into another debacle such as the debt ceiling issue, which is on the table for mid-October. The U.S. Treasury will not have authority to borrow when it hits the statutory debt limit of $16.7 trillion in about two weeks.
How might things play out?
Many think that demands to defund the ACA will be set aside temporarily and Congress will decide to fund the federal government for a short period. But there is the potential that passions could re-emerge during debate over the debt ceiling. Policy-makers could be back at an impasse later this month, with the stakes considerably higher.
A delay in raising the debt ceiling would trigger some unpleasant developments. The U.S. Treasury will be able to spend only what it takes in. According to the Bipartisan Policy Center, only 70% of federal obligations can be paid during the 20 business days after the debt ceiling is breached. Tough choices may be needed on which payments can be sustained: interest on Treasury securities, Medicare/Medicaid and Social Security, among them.
The Treasury may not default on debt obligations, but the global market reaction to a hard debt ceiling could be of outsized magnitude. Further downgrades of U.S. debt cannot be ruled out. While markets have performed reasonably well during past shutdowns, current circumstances may be seen as more threatening, given lingering limitations stemming from the financial crisis.
It is certainly disappointing that it has come to this, but for those who have been observing the American political process over the last decade, it is hardly surprising. One can only hope that the legislature can pull itself away from the brink before driving us over it.