Understanding the Impact of Government Shutdowns on Economic Recessions

As we look at markets and the economy, our goal is always to provide perspective for our clients. We understand that news headlines can send mixed messages, so we want to make sure you’re informed on what is most important to your financial progress.

The government shutdown is at the forefront of the current news cycle and is now entering its third week. We expect these headlines to grow louder, adding to political noise and perhaps polarization. For investors, there are also growing concerns of a possible recession.

To be clear, the goal of financial planning is not to take sides on which side of Washington is “right,” but rather to make sense of it all, especially with an eye toward risks and opportunities. Here are some views that we hope you find helpful in the coming days.

The Facts: The Latest on the Government Shutdown

The current government shutdown is now in the top five longest shutdowns ever and it’s not yet clear when an agreement will be reached. Congress must either pass a new funding bill or agree on a temporary one to reopen the government. Unfortunately, shutdowns have become normal in Washington.

The shutdown primarily affects government workers and their families. By law, furloughed employees should receive all backpay once the shutdown ends. It also impacts those who depend on government services, although many services such as Social Security checks should not be impacted. If you are affected, whether directly or indirectly via people you know, please let me know and I’d be happy to provide financial guidance where helpful. 

While there are real-world impacts to the shutdown, it’s important to separate these from the economic effects when considering our financial plans and investment decisions. For economists and investors, we have a window with no government economic data releases, making it more challenging to identify employment and inflation trends.

As investors, it is important to recognize that government shutdowns have never had long-term effects on the stock market. The longest shutdown in history was during President Trump’s first term from 2018 to early 2019, lasting 35 days. Not only were the markets and economy fine, but the S&P 500 also rose 31.5% with dividends in 2019. While the past is no guarantee of the future, this chart shows that historical shutdowns often had a limited impact, regardless of which party was in power.

So, why is the government shutdown making financial headlines today? First, extended shutdowns can create modest economic growth headwinds as federal employees postpone spending and government services experience disruptions. While there may be some lost economic growth during this period, much of this is simply postponed until the government reopens.

Perhaps the most important difference with this shutdown is government layoffs, also known as “reductions in force,” (RIF). In this case, the core issue is that the job market has already been weakening since the spring, causing moderate recession concerns.

Without minimizing the real-world challenges this can create for government workers and their families, it’s important to note that federal government employment only makes up 1.8% of the entire workforce. To put this in context, the 4,000 RIF notices recently sent represent 0.1% of the federal workforce, or 0.0018% of the total labor market. Again, the goal is not to overlook the individual challenges this can create, but to understand that this is only a small slice of the entire economy.

Keep in mind that the shutdown is different from other fiscal challenges in Washington. The “debt ceiling,” for instance, is what has led to downgrades of the U.S. debt and worries about a default on Treasurys, in the past. This is distinct from the shutdown which is about how to fund different parts of the government.

Recession concerns are a regular feature of investing - we have had countless occasions where economists “jumped at shadows,” including earlier this year. No other market factors are likely to materially change. The key drivers of investments, such as corporate earnings, valuations, interest rates, and inflation are unlikely to significantly shift as a result of the government shutdown.

The Broader Impact of Government Shutdowns

Taken together, government shutdowns will likely attract media attention, present difficulties for federal employees, and interrupt essential services, but they historically represent temporary interruptions and have minimal financial market impact. Related to your situation, the government shutdown is not a reason to make changes to your financial plan. That said, if your financial situation or objectives have shifted, please don’t hesitate to reach out and we’ll explore it in detail together.