The partial U.S. government shutdown that began on 22 December 2018 has entered its record-setting fourth week, with no clear resolution in sight. Although the $5.7 billion of border wall funding at the heart of the shutdown is small relative to the annual $4 trillion government budget, its symbolic significance is such that neither side seems close to relenting – nor does a bigger deal on immigration seem likely.
The shutdown affects 25% of the government, with more than 800,000 employees either furloughed or working without pay and a panoply of functions currently offline. While we believe the shutdown on its own would have only a modest impact on growth, the combined impact of this and other short-term drags on the economy could slow first-quarter growth close to the zero mark – an outcome that would weigh on markets and make the Federal Reserve’s decision about whether to pause rate hikes in March even more straightforward.
Dim prospects for a deal
Our view is that a negotiated resolution between President Donald Trump and congressional Democrats is unlikely and that the president will ultimately declare an emergency under the 1976 National Emergencies Act, which would allow him to reappropriate already allocated dollars toward building his desired wall on the southern border.
While this move would likely be contested (and potentially blocked) in the courts – not to mention draw the ire of conservative Republicans, who consistently complained of executive overreach by President Barack Obama – it could achieve two desirable political outcomes for the president: 1) It would show the president’s base of support that he is committed to building the border wall and will do anything to follow through on his promise; and 2) It would allow him to reopen the government and therefore help mitigate any further political fallout (according to RealClearPolitics polls, the president’s approval ratings have suffered during the shutdown).
The economic costs of the government shutdown are rising. We estimate that the reduction in government hours worked will dent real GDP growth by 0.1 percentage point for fourth-quarter 2018 and by 0.3–0.4 percentage point in the first quarter of this year, assuming the government reopens relatively soon – a modest but likely permanent hit to real GDP. In the past, Congress has made up the lost pay for furloughed workers, and we would expect them to do so again. However, because the Bureau of Economic Analysis (BEA) measures real government consumption by estimating the number of hours worked by government employees, and since the lost hours of furloughed employees are not likely to be made up later, the lost GDP will likely never be regained.
These estimates don’t consider the indirect economic effects of the shutdown, including the impact on consumption or private wages and salaries. Furthermore, other factors may also exert a temporary drag on first-quarter growth. For a number of years, U.S. real GDP growth has tended to temporarily slow in the first quarter, only to reaccelerate in the second. This “residual seasonality” has been noteworthy enough that the BEA has taken measures to correct it. However, two additional factors have emerged more recently that may similarly depress first-quarter real GDP growth. First, e-commerce retailers’ rising market share appears to be shifting consumption into months with large promotions, including fourth-quarter holiday sales events, resulting in lower spending in the first quarter. And second, the Treasury Department’s fraud prevention efforts have resulted in temporary delays in tax refunds to individuals claiming earned income and child tax credits, which has tended to push some consumption out of the first quarter and into the second.
We also note growing evidence that the Trump administration’s previous threats of increasing tariffs on Chinese imports resulted in a pickup in U.S. growth in the second half of 2018, as firms rushed to produce and stock inventories ahead of a rise in customs duties. That trend could start to reverse in the first quarter.
Growth forecast: Heading toward zero in the first quarter?
Considering the various factors, our early forecast for U.S. real GDP growth is 0.5% for the first quarter, a significant deceleration from the roughly 3% pace in 2018. Although many of the contributing factors are likely temporary, and we expect full-year 2019 growth ultimately to be modestly above trend, the deceleration may weigh on markets and further deepen investors’ uncertainty about the economic outlook.
For more of our views on how policy could move markets this year, see our 2019 U.S. policy outlook.
Libby Cantrill is PIMCO’s head of public policy, and Tiffany Wilding is a PIMCO economist focusing on the U.S. Both are regular contributors to the PIMCO Blog.