Maybe the government shutdown won’t clobber the economy, after all

October 6, 2013

It has been a good weekend for anyone worrying about the effect that the federal government shutdown will have on economic growth. Krishna Guha of the ISI Group notes that two developments mean that the hit to GDP from the shutdown should be smaller than analysts have been estimating.

First, the Defense Department has brought all civilian personnel back to work immediately, deeming them all "essential employees." Second, the House passed legislation to give back-pay to federal workers who are furloughed when the shutdown ends (Senate approval and a presidential signature will almost certainly follow).

The most important channel through which the shutdown was poised to affect the economy in the short-run was through reduced incomes for federal employees. But now they are poised to receive that income anyway, so there shouldn't be any major disruption to fourth quarter gross domestic product or other key economic measures (the month-to-month numbers could still end up showing some odd blips if the shutdown extends much longer).

Writes Guha in a research note Sunday:

Consumption will still be affected, because many of the federal workers promised backdated pay are liquidity constrained (they will struggle to maintain consumption while keeping up with mortgage payments etc).  But the decline should be much smaller than it would have been absent these developments.

In other words, some of the higher estimates of the impact of a shutdown, as shown in this chart:

shutdown_impact

may well turn out to be off-base given that government workers will ultimately get paid for the lost time.

Of course, all of this is blown out of the water if the dispute over raising the debt ceiling persists long enough that there is a default or near-default on the U.S. government's obligations. In the event of a new, self-induced fiscal crisis, all bets are off on how much GDP growth and other measures of economic well-being will be affected. It almost certainly will not be measured as a few tenths of a percent of growth confined to a single quarter.

And Guha notes a problem that could arise from the measures that reduce the economic damage from the shutdown: "The risk . . . is that a shutdown that imposes a smaller degree of economic harm in fewer Congressional constituencies could also be more politically tolerable and therefore last longer - becoming a chronic rather than acute problem for the economy.  So it is possible that while the economic cost per week of shutdown is now lower the ultimate economic cost might not be."

In other words: Less intense economic pain may mean that the damage from the government shutdown may also mean that it goes on a lot longer.

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Ezra Klein · October 6, 2013