The economic consequences of the current closure of the federal government depend fundamentally on how long it lasts. If it is solved quickly, the costs will be small, but if it extends, it could make the US economy be bite.
This is because the economy is already in a precarious state, with the labor market in trouble, consumers losing confidence and increasing uncertainty.
As an economist who studies public finances, I closely follow how government policies affect the economy. Let me explain how prolonged closure could affect the economy and why it could be a turning point towards recession.
Direct impacts of a government closure
The partial closure of the government began on October 1, when Democrats and Republicans failed to reach an agreement on the financing of a part of the federal government. A partial closure means that some financing laws were approved, the rights spending continues since it does not depend on the annual assignments, and some workers are considered necessary and remain at work without collecting.
While most of the 20 closures that occurred from 1976 to 2024 lasted only a few days to a week, there are signs that the current one may not be resolved so fast. The economy would definitely suffer a direct blow to the gross domestic product due to prolonged closure, but it is the indirect impacts that could be more harmful.
The most recent closure, which extended during the 2018-2019 winter holidays and lasted 35 days, was the longest in the history of the United States. After it ended, the Congress Budget Office estimated that the partial closure delayed approximately 18,000 million dollars in discretionary federal expenses, which resulted in a reduction of 11,000 million in the real GDP.
Most of that lost production was later recovered once the closure ended, the CBO said. He estimated that permanent losses were around 3,000 million dollars, a drop in the ocean for the US 30 billion economy.
The indirect and more durable impacts
The total impact can depend largely on average consumer psychology.
Recent data suggest that consumer confidence is falling as the work market stagnation becomes more evident. Business confidence has been mixed, since the manufacturing index continues to indicate that the sector is in contraction, while other business confidence measures indicate mixed expectations about the future.
If the closure is prolonged, the psychological effects can lead to a greater loss of confidence between consumers and companies. Since consumer spending represents 70% of economic activity, a fall in consumer confidence could indicate a turning point in the economy.
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These indirect effects are added to the direct impact of the loss of income for federal workers and those operating with federal contracts, which leads to reductions in consumption and production.
The risk of significant government dismissals, beyond the usual licenses, could deepen economic damage. Prolonged dismissals would change the losses of a temporary delay to a more permanent loss of income and human capital, reducing aggregate demand and potentially increasing the effects of contagion of unemployment in the private sector.
In summary, although the closures that end quickly tend to inflict modest losses, mostly recoverable, a prolonged closure, especially one that involves the dismissal of a significant number of government workers, could inflict larger and larger impacts on the economy.
The EU economy is already in difficulties
All this is happening while the US labor market is broadcasting warnings.
The payrolls grew only in 22,000 in August, and the estimates of July and June were checked down in 21,000. This follows the payroll growth of only 73,000 in July, with May and June estimates reviewed down 258,000. In addition, preliminary annual reviews of employment data show that the economy won 911,000 jobs less in the previous year than it had been informed.
Long -term unemployment is also increasing, with 1.8 million people without work for more than 27 weeks, almost a quarter of the total number of unemployed people.
At the same time, the adoption of AI and cost reduction could further reduce labor demand, while the aging of workforce and lower immigration reduce labor supply. The president of the FED, Jerome Powell, refers to this as a “curious type of balance” in the labor market.
In other words, the labor market seems to have stopped dry, which makes it difficult for the new graduates to find work. The unemployment of the newly graduated, that is, those who are between 22 and 27 years old, are now 5.3% in relation to the total unemployment rate of 4.3%.
The latest DP Employment Report data, which measures only private companies data, show that the economy lost 32,000 jobs in September. That is the greatest decrease in two and a half years. While that is worrying, economists as I generally expect the official figures of the Office of Labor Statistics to leave to confirm the accuracy of the payroll processing company report.
Government data that would be supposed to leave on October 3 could have offered a possible counterpoint to the bad news of ADP, but due to closing, BLS will not publish the report.
Problems that Fed feat cuts cannot solve
This will only increase the uncertainty surrounding the health of the US economy. And it adds to the uncertainty created by intermittent tariffs, as well as for tariffs recently taxes on wood, furniture and other goods.
In this context, Fed is expected to lower interest rates at least twice this year to stimulate consumers and companies after their cutting quarter in September. This increases the risk of rekindling inflation, but cooling of the labor market is a more immediate concern for Fed.
While lower short -term rates can help on the margin, I think they cannot resolve deeper challenges, such as massive public deficits and debt, adjusted family budgets, a crisis of affordability of housing and an increasingly reduced workforce.
The question now is not whether the Fed will cut the rates, because it will probably do so, but if that cut will help, particularly if the closure lasts weeks or more. Monetary policy alone cannot overcome the uncertainty created by tariffs, the lack of fiscal restriction, companies focused on reducing costs replacing people with technology, the impact of closure and fears of consumers on the future.
The lowest interest rates can gain time, but they will not solve these structural problems facing the US economy.
*John W. Diamond is director of the Public Finance Center of the Baker Institute at the University of Rice.
This article was originally published in The Conversation
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