With just over 24 hours left until the US Federal Government may be shut down on Friday night should Republicans and Democrats fail to reach a "stop-gap" spending bill, something which is increasingly likely after Mitch McConnell said he is "planning for a government shutdown", clearly a political gambit yet one which may backfire and result in precisely what it is meant to avoid, the question then is what happens next.
Conveniently, this morning Goldman answers precisely that question.
But first, here is how the vampire squid handicaps the odds of a government shutdown today: as Hatzius et al write, "there appears to be a substantial chance of a government shutdown at the end of the week. At the moment, we believe the odds of a lapse in spending authority after Friday, January 19, stand at around 35%."
Here Goldman appears unduly optimistic...
- WHITE HOUSE SOURCES PEG CHANCES OF GOVT SHUTDOWN AT 50%: FOX
... Although even at 35%, this is a surprisingly high number. Why?
Well, because "the high-profile nature of the immigration debate and the lack of consensus among Republicans raise the probability that congressional Democrats will oppose an extension of spending authority."
So with odds high and rising, the chance of a misstep, especially with Trump's loose twitter-finger, is likely much higher than Goldman's oddsbefore Goldman explains what happens next, first a quick look at the history of government shutdowns.
Shutdowns are rare—before 2013, the most recent shutdown had ended in early 1996—because a short-term extension is always a possibility if a long-term agreement cannot be reached. In the fiscal year that started October 1, 2017, Congress has already enacted multiple short-term extensions of spending authority, and Republican leaders hope to enact another short-term extension through February 16 this week.
Shutdowns usually happen because of broad high-profile political disagreements that do not relate to the spending legislation itself. In 2013, for example, Republican lawmakers pressed to include a delay in some or all of the Affordable Care Act (ACA) in spending legislation; by the deadline, the issues had been conflated to the point that a vote to extend spending authority and avoid a shutdown was seen by some as the political equivalent of endorsing the ACA. With recent political developments putting a spotlight on immigration policies and the upcoming expiration of the deferred action for childhood arrivals (DACA) program on March 5, there are parallels between the ACA debate in 2013 that led to a shutdown, and the immigration debate this year.
Shutdowns have also usually occurred under divided government. While the minority party can block spending legislation in the Senate if they have at least 41 votes, this generally does not happen, presumably because it would mean the cause of the shutdown could be easily identified. By contrast, under divided government, either or both parties might be blamed. Republicans currently control Congress and the White House but Republican leaders often rely on Democratic votes to offset opposition among some Republican lawmakers to spending bills and other fiscal legislation. If some Republicans vote against spending legislation, particularly when it comes up for a vote in the House, Republican leaders would likely find it more difficult to attribute the shutdown to congressional Democrats when members of both parties voted against the bill.
The next question is what happens if the government passes yet another short-term stopgap measure. According to Goldman, avoiding a shutdown now - temporarily - would increase the risk later in Q1, and the bank thinks the risks are higher around the next deadline, likely to be February 16, than they are this time, for three reasons:
- First, the decisions are likely to be harder. Next month, Congress is likely to try to assemble a legislative package that includes, among other things, an extension of spending authority through the remainder of the fiscal year, an increase in the caps on spending in FY2018 and FY2019 of around $100bn per year, additional disaster relief funds, a suspension of the debt limit into 2019, and an immigration agreement that pairs a DACA compromise with border enforcement funding.
- Second, another short-term extension might be difficult. While a short-term stopgap measure might be an acceptable compromise this week, another short-term extension next month is less likely to be acceptable to congressional Democrats, as they are likely to press for a permanent solution to the DACA program ahead of the March 5 deadline noted above. More generally, we expect that many lawmakers have grown increasingly wary of further temporary extensions and might decline to support another continuing resolution next month.
- Third, the risks to the economy and financial markets are somewhat higher in February than they are this month, due to the upcoming debt limit deadline. The Treasury appears to be targeting a February 28 deadline for the debt limit. While fiscal projections are particularly difficult right now given strong underlying revenue growth offset by the impact of the phase-in of tax cut, this estimate appears somewhat conservative to us and we expect that the Treasury should be able to continue borrowing through at least the first half of March, if necessary.
So let's say come midnight on Friday and there is no deal, what happens once the government is shut down? Well, for those who don't remember the last time the government was frozen for several days, here is a reminder of what happens to the US economy and DC once we cross D-Day:
A government shutdown has a much more modest impact than the term might suggest. First, only a portion of the government actually shuts down when spending authority lapses. In prior experiences, about 40% of the federal workforce, or about 800,000 workers, have been furloughed without pay during shutdowns. The remaining 60% is considered exempt because they perform duties related to health, safety, security, or financial operations, among other activities. We estimate that these furloughs would reduce real GDP growth in Q1 by about 0.2pp qoq for each week that a shutdown lasted, though the effect would reverse the following quarter. If a shutdown lasted several weeks, the weekly effect might rise slightly as federal contractors and procurement could also begin to be affected.
If Congress voted to retroactively pay federal workers for work missed, as they have in all prior shutdowns, there would be no meaningful direct effect on personal income. That said, a prolonged shutdown could dampen consumer sentiment. For example, the Conference Board and University of Michigan consumer sentiment surveys declined by an average of 7 points in the month of the three previous major shutdowns (November 1995, December 1995-January 1996, and October 2013) and gained about half of the decline, on average, the following month.
What about the market?
Markets have tended to shrug off shutdowns as long as the debt limit is not involved. The 1995, 1995-96, and 2013 government shutdowns had a modest effect on financial markets (Exhibit 1). The dollar weakened slightly in all three cases in the few days following each shutdown, with a further leg down in 2013 as the debt limit deadline approached. Treasury yields did not react meaningfully at the start of these shutdowns. The equity market reaction was inconsistent, with a slight decline in the early days of the December 1995 and October 2013 episodes, but no real change around the November 1995 shutdowns.
Beyond the three shutdowns just noted, there were another series of shorter shutdowns that occurred in the 1980s that lasted only a few days apiece. Exhibit 2 shows the median change in equities, rates and the dollar around each of these shutdowns, and suggests that while equities have declined modestly at the start of prior short shutdowns, moves in other assets have been limited.
In Goldman's summary, the bank views, the current situation as s different from the longer shutdowns in the mid-1990s and 2013 "because the debt limit deadline is still more than a month away."
By contrast, in 1995 the first shutdown occurred after the Treasury’s stated debt limit deadline had passed, which had already led the Treasury to postpone scheduled Treasury auctions. In 2013, the shutdown started a little more than two weeks before the debt limit deadline. While the two were initially seen as separate, markets quickly came to the conclusion that the shutdown would end only once the debt limit was raised. This time around, if a shutdown occurred at the end of the week, the debt limit deadline would be around six weeks away from the Treasury’s target, and even farther from our own estimate.
Well, if nothing bad will happen, let's get it on then and see just how right Goldman really is.