US economy is already on the edge – a prolonged government shutdown could send it tumbling over

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John W. Diamond, Rice University

(THE CONVERSATION) The financial penalties of the present federal authorities shutdown hinge critically on how lengthy it lasts. Whether it is resolved rapidly, the prices shall be small, but when it drags on, it may ship the U.S. economic system right into a tailspin.

That’s as a result of the economic system is already in a precarious state, with the labor market struggling, shoppers dropping confidence and uncertainty mounting.

As an economist who studies public finance, I intently observe how authorities insurance policies have an effect on the economic system. Let me clarify how a chronic shutdown may have an effect on the economic system – and why it could possibly be a tipping level to recession.

Direct impacts from a authorities shutdown

The partial authorities shutdown began on Oct. 1, 2025, as Democrats and Republicans failed to achieve a deal on funding some portion of the federal authorities. A partial shutdown signifies that some funding payments have been permitted, entitlement spending continues because it doesn’t depend on annual appropriations, and a few employees are deemed needed and keep on the job unpaid.

Whereas a lot of the 20 shutdowns that occurred from 1976 by 2024 lasted only a few days to per week, there are indicators the present one may not be resolved so quickly. The economic system would positively take a direct hit to gross home product from a prolonged shutdown, but it surely’s the oblique impacts that could possibly be extra dangerous.

The latest shutdown, which prolonged over the 2018-2019 winter holidays and lasted 35 days, was the longest in U.S. historical past. After it ended, the Congressional Funds Workplace estimated the partial shutdown delayed roughly US$18 billion in federal discretionary spending, which translated into an $11 billion discount in actual GDP.

Most of that misplaced output was made up later as soon as the shutdown ended, the CBO famous. It estimated that the everlasting losses had been about $3 billion – a drop within the bucket for the $30 trillion U.S. economy.

The oblique and extra lasting impacts

The complete impression might rely to a big extent on the psychology of the common shopper.

Latest knowledge means that consumer confidence is falling because the stagnation within the labor market turns into extra clear. Enterprise confidence has been combined because the manufacturing index continues to point the sector is in contraction, whereas other business confidence measures point out combined expectations in regards to the future.

If the shutdown drags on, the psychological results might result in a bigger lack of confidence amongst shoppers and companies. Provided that shopper spending accounts for 70% of financial exercise, a fall in consumer confidence may sign a turning level within the economic system.

These oblique results are along with the direct impression of misplaced earnings for federal employees and people who function on federal contracts, which ends up in reductions in consumption and manufacturing.

The chance of great authorities layoffs, past the same old furloughs, may deepen the financial injury. In depth layoffs would shift the losses from a brief delay to a extra everlasting lack of earnings and human capital, lowering mixture demand and doubtlessly growing unemployment spillovers into the non-public sector.

In brief, whereas shutdowns that finish rapidly are inclined to inflict modest, principally recoverable losses, a protracted shutdown – particularly one involving layoffs of a major variety of authorities employees – may inflict bigger, lasting impacts on the economic system.

US economic system is already in misery

That is all occurring because the U.S. labor market is flashing warnings.

Payrolls grew by only 22,000 in August, with July and June estimates revised down by 21,000. This follows payroll development of solely 73,000 in July, with Could and June estimates revised down by 258,000.
As well as, preliminary annual revisions to the employment knowledge present the economic system gained 911,000 fewer jobs within the earlier yr than had been reported.

Lengthy-term unemployment can also be rising, with 1.8 million individuals out of labor for greater than 27 weeks – almost 1 / 4 of the total number of unemployed individuals.

On the identical time, AI adoption and cost-cutting may additional scale back labor demand, whereas an getting old workforce and decrease immigration shrink labor provide. Fed Chair Jerome Powell refers to this as a “curious kind of balance” within the labor market.

In different phrases, the job market seems to have come to a screeching halt, making it troublesome for latest graduates to search out work. Latest graduate unemployment – that’s, those that are 22 to 27 years outdated – is now 5.3% relative to the overall unemployment charge of 4.3%.

The newest knowledge from the ADP employment report, which measures solely non-public firm knowledge, exhibits that the economic system misplaced 32,000 jobs in September. That’s the biggest decline in 2½ years. Whereas that’s worrying, economists like me often look ahead to the official Bureau of Labor Statistics numbers to return out to substantiate the accuracy of the payroll processing agency’s report.

The federal government knowledge that was supposed to return out on Oct. 3 might need provided a potential counterpoint to the unhealthy ADP information, however as a result of shutdown BLS is not going to be releasing the report.

Issues Fed charge cuts can’t repair

This can solely improve the uncertainty surrounding the well being of the U.S. economic system. And it provides to the uncertainty created by on-again, off-again tariffs in addition to the newly imposed tariffs on lumber, furnishings and different items.

In opposition to this backdrop, the Fed is expected to lower rates of interest not less than two extra instances this yr to stimulate shopper and enterprise spending following its September quarter-point cut. This raises the danger of reigniting inflation, however the cooling labor market is a extra instant concern for the Fed.

Whereas decrease short-term charges might assist on the margin, I imagine they can’t resolve the deeper challenges, reminiscent of huge authorities deficits and debt, tight household budgets, a housing affordability crisis and a shrinking labor force.

The query now isn’t will the Fed lower charges, as a result of it doubtless will, however whether or not that lower will assist, notably if the shutdown lasts weeks or extra. Financial coverage alone can’t overcome the uncertainty created by tariffs, the shortage of fiscal restraint, firms centered on chopping prices by changing individuals with know-how, the impression of the shutdown and the fears of shoppers in regards to the future.

Decrease rates of interest might purchase time, however they gained’t resolve these structural issues dealing with the U.S. economic system.

This text is republished from The Dialog below a Inventive Commons license. Learn the unique article right here: https://theconversation.com/us-economy-is-already-on-the-edge-a-prolonged-government-shutdown-could-send-it-tumbling-over-266327.