The U.S. Congress and Administration could not agree on a budget to fund the activities of the federal government in the fiscal year that begins today. As a result, many federal government operations have been shut down, and its employees will be furloughed until the budget is funded. This is the first of two major confrontations over budget policy that will dominate the U.S. political landscape during October. The second debate will be over the debt ceiling, the maximum amount of outstanding debt the federal government is legally permitted. It was a confrontation over the debt ceiling back in 2011 that put Congress and the President in the position we see today. The immediate, short-term impact of the inability to agree on a budget is negative for the U.S. economy, as it increases the uncertainty that has held back the private sector for the past two years.
It is difficult to say how long this impasse will persist, as there are strong ideological forces on both sides that appear unwilling to compromise. The last time this happened was in two separate shutdowns in 1995-1996. The first took place from November 14 to November 19 in 1995, followed shortly after by a shutdown from December 16, 1995 to January 6, 1996, for a total of 28 days. That standoff had almost no impact on the U.S. economy. In 1995, U.S. GDP grew by 2.7%, and, in 1996, it expanded by 3.8%.
But today’s economy is much different than it was in 1995-1996. Despite healthy fundamentals — including a recovering housing sector, building pent-up demand, high levels of corporate profitability, and much-improved household balance sheets — economic growth has been weak for the past two years as uncertainty about government policy and the global environment have prompted businesses and households to be cautious. As a result, hiring is sluggish and GDP growth is running at about 2.0%. Consumers and businesses are nowhere near as optimistic as they were in the mid-1990s. It’s this fragile confidence in an already weak economy that makes the current confrontation negative for the near-term economic outlook. Already cautious households and businesses will hold off spending and investing until there is more clarity about the budget.
Perhaps more important to the longer-term outlook for the U.S. economy will be the debt ceiling debate that will take place over the next few weeks. The Treasury Department currently estimates that the U.S. will run out of room to borrow sometime around October 17 to October 22. If Congress does not raise the debt ceiling, the government will not be able to pay its obligations. The debt ceiling has always been used as a political mechanism by both parties to try and promote their agenda, and this time will likely be no different. In 2011, the drive to lower the budget deficit created the “fiscal cliff” that was implemented at the beginning of the year.
It’s not clear at this time how the debate will unfold, but it is likely that a confrontation over tax and spending policy will be an important part of the discussion. The longer these issues remain unresolved, the more negative the impact on the U.S. economy.
We are currently forecasting a significant acceleration in growth for the U.S. economy in 2014 as the underlying improvement drives growth. After growing by about 2.0% in 2013, we expect the economy to grow by somewhere between 3.0% and 3.5% in 2014. However, a key component of this forecast is the assumption that Congress and the President are able to reach a compromise that creates greater certainty about the fiscal environment. Lack of such an agreement would severely constrain growth and keep the U.S. economy locked in the 2.0% growth twilight zone that it has inhabited for much of the past four years.
CONCLUSIONS. The next big challenge will be the U.S. budget debate. That debate is now upon us, and it is not starting out well. While we do not believe the current partial government shutdown will have any lasting economic impact — unless it is prolonged — the inability to agree on a budget is an ominous sign for the next stage of negotiations on the debt ceiling and longer-term tax and spending policies. There is currently a great deal of dysfunction in Washington, and the longer it goes on, the greater the threat to the U.S. economy. It is not likely to push the economy into recession, but a continuation of the current confrontation will hold back growth and opportunity for everyone.
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