You’re forgiven for thinking that the bipartisan budget agreement signed by President Biden last June—thus avoiding a federal debt default—meant there would be no big budget conflicts for the rest of the year. That legislation, you might recall, suspended the debt ceiling until Jan. 1, 2025, and limited federal spending for two years. A big relief for financial markets, to be sure.
But that was then and this is now. And a different sort of budget fight is brewing. The Biden White House wants Congress to pass a short-term funding measure to keep the government operating after the current budget year ends September 30. Without such a measure, parts of the federal government could shut down when the new budget year begins on Oct. 1. The shutdown risk stems from disagreements between Democrats and the GOP’s House Freedom Caucus, which wants spending cuts beyond what Biden and House Speaker Kevin McCarthy agreed to in their May debt ceiling compromise, as well as changes to federal border policy .
The good news here is that any shutdown is unlikely to last long. So no big economic impact and little market reaction, probably. As Goldman Sachs explains it:
A government-wide shutdown would directly reduce growth by around 0.15pp for each week it lasted; including modest private sector effects, the hit to growth could be around 0.2pp per week. In the quarter following reopening, growth would rise by the same amount. Markets have not reacted strongly to prior shutdowns. At the end of the 3 prolonged shutdowns in the past (1995-96, 2013, and 2018-19), equity markets finished flat or up, though in each instance equity prices were lower at some point in the days following the start of the shutdown than when it began. By contrast, the 10-yr Treasury yield declined more consistently following the start of prior extended shutdowns.
Indeed, the probable lack of economic impact and market reaction makes a shutdown more likely. And in the end, the whole exercise looks performative rather than substantive. If you care about the long-term fiscal trajectory of the federal government, then you should be engaging on issues such as entitlement reform, creating a tax code that raises more revenue efficiently, and policies to increase the economy’s productive capacity. That’s what substance looks like.
CLICK HERE TO READ MORE FROM RESTORING AMERICAThis article originally appeared in the AEIdeas blog and is reprinted with kind permission from the American Enterprise Institute.