Goldman Explains How SHTF (Or Not) If Congress Can't Avoid Latest Looming Shutdown

As yet another shutdown is looming, a panic has begun to spread through the media and Washington DC.

Alec Phillips, Goldman's Alec Phillips, explains the possible consequences of burning your hand again on the stove.

The economic impact of a government shutdown is predictable because the rules are well-defined and have been in place before. Federal spending accounts for almost a quarter (25%) of the GDP.

The impact of a shut down is much less, for

Four key reasons

:

The Discretionary Budget is the Key

The federal budget is divided into three broad categories: discretionary (like defense), compulsory (Medicare and Social Security) and interest on the public debt. During a shutdown, only discretionary expenditures are affected. This is around 6.5% GDP.

Not all departments are created equal

Some departments could remain open, while others may close. The Department of Defense has been spared from prolonged shutdowns, as it accounts for about half of all discretionary expenditures. Since none of the standard 12 appropriations bills has passed, this time the shutdown will be all-encompassing, but limited to discretionary spending.

Low Impact Investment and Goods

Shutdowns affect employment in the federal government more than investments or purchases of goods and service. Federal employees' pay makes up about 2% of the GDP. A shutdown would result in a reduction of work, which would affect only 0.5%.

The majority of federal employees would still be working

Around 800k federal civilian employees would be furloughed. The essential services will continue and the active duty military personnel will remain.

What's more,

Market reactions to the government shutdown have become more muted

Given that despite high odds of a shut down,

The funding is usually provided at the eleventh hour through a "continuing resoluton"

It is important to provide temporary funds at the beginning of the fiscal year on Oct. 1, which will eventually translate into longer-term expenditure bills. Failure to either of these things will lead to a government shutdown, which is looking likely at this time.

While a shutdown may 'briefly affect consumer confidence'

The modest effects on the economy and market are not surprising.

It would have a minimal impact on monetary policy

If the shutdown is prolonged and starts in October, then the FOMC's argument will be bolstered.

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Goldman anticipates that the FOMC will remain on hold during its November meeting. The FOMC has in the past downplayed economic impacts of shutdowns, focusing on potential effects to economic data reporting.

Phillips makes the following point:

The likelihood of a government shutdown in the future is increasing.

We noted at the beginning of the year that there was a high probability of a shutdown of the government. This became the case after the June debt limit agreement, due to the small House majority and the disagreement over spending levels.

The chances of a shutdown are at least as good as they were then.

If Congress fails to pass the annual spending bills, a shutdown will occur. The funding is usually provided first by a short-term "continuing resolution" to provide temporary funds at the beginning of the fiscal (Oct.1) year, and then finally through full-year expenditure bills. If either fails to pass, a shutdown will occur.

Shutdowns in the past have been caused by disagreements over spending levels or distribution, or issues unrelated to spending that one party wanted to include in legislation.

Both types of risk are present at the moment.

The 'Fiscal Responsibilty Act' (FRA), passed by Congress in June, to increase the debt limit, should have put an end to the debate about spending levels.

Three provisions were included in the FRA.

:

Budget caps for FY2024-25

If Congress exceeds the cap, then cuts across-the board (also known as "sequestration") will bring back spending. Although the caps limit the spending, Congress still must pass spending bills in order to provide funding.

The Democrats could add back the majority of non-defense funds cut by the caps deal through a'side agreement' to the FRA

To make these changes, Congress will still need to pass spending bills.

Automatic reduction of 1% from FY2023 levels

If Congress does not pass all 12 full-year budget bills by Jan. 1, 2024, and it is still operating on a continuing resolution, the law will take effect. Exhibit 1 shows that defense spending would be reduced below the caps while non-defense spending would increase slightly above.

But it would still be a modest amount compared to a'side-deal'.

Note:

Last week, House Speaker Kevin McCarthy floated an interim government funding bill

Avoid shutdown this Fall, according to

NBC News

.

Two sources familiar with the situation told NBC News that McCarty believes Congress must pass a bill for short-term funding to avoid a government shutdown in the fall.

The remarks show a growing awareness that Congress does not have time to come up with a funding agreement for the entire year before September 30. The lawmakers are on a one-month August break and will return to work in September just a few short weeks before the deadline.

McCarthy has privately agreed that Congress must buy time in order to reach a funding agreement, but it is not clear what they will demand.

McCarthy, R. California, said he did not want to set a date that would push Congress into the Christmas holidays. McCarthy's stopgap measure was not specified by a second GOP source.

Goldman believes that the likelihood of a short shutdown is high. However, its impact will be minimal and mostly reversible.