Adding Up the Economic Cost of Political Dysfunction

Money

Source: http://www.flickr.com/photos/jackofspades/

After more than two weeks of brinkmanship that pushed the U.S. government through a partial shutdown and to the doorstep of its borrowing limit, both houses of Congress have voted to pass a stopgap measure to fund the government through January 15 and suspend the debt limit through February 7.

The measure passed the Senate 81-18, cleared the House 285-144, and was signed promptly by President Barack Obama late on Wednesday night. The legislation effectively established a temporary political ceasefire, suspending the use of government funding and the debt limit — as well as the specter of default — the only weapons powerful enough to really do anything in what has become full-blown political trench warfare in Washington.

With these political weapons of mass destruction banished for the time being, we can use the respite to take stock of the economic damage caused by the fiscal battle that just took place in Washington.

Quantifying the economic impact of debt limit brinkmanship and the 16-day partial government shutdown is not a straightforward task. For example, brinkmanship — the art of eleventh-hour deal making — is a game in which the party that pushes Uncle Sam closest to the edge of a cliff without actually sending him toppling over wins. The uncertainty bred by brinkmanship is absolutely an economic headwind, but its effects are hard to measure.

The closest we can come is to measure the uncertainty itself using metrics like economic confidence, which Gallup computes on a rolling basis. Gallup’s Economic Confidence Index fell from -20 at the beginning of September to a trough of -43 in the October 10-12 period, its lowest level since 2011 and the last time politicians used the debt limit as leverage. The index averaged -39 for the week ended October 11.

Gallup ECI2

So people lose confidence in the economy when the federal government comes to a standstill over fiscal issues — no real surprise here. It’s also not very surprising that when a toxic political situation threatens economic catastrophe, those tasked with rating the default risk on debt start to speak up. Fitch Ratings, one of the major ratings services, placed U.S. debt on Rating Watch Negative this week, a direct result of the brinkmanship in Washington.

“Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default,” Fitch said. “The repeated brinkmanship over raising the debt ceiling also dents confidence in the effectiveness of the U.S. government and political institutions, and in the coherence and credibility of economic policy. It will also have some detrimental effect on the U.S. economy.”

Testifying before Congress on October 10, Treasury Secretary Jack Lew said that private-sector economists estimated the damage of a two-week shutdown to be a 0.25 percent reduction to fourth-quarter gross domestic product growth.

“Some have warned that a longer shutdown would reduce economic growth as much as 1.5 percentage points,” Lew said. “These estimates typically do not include the additional spillovers that seem likely. Household and business confidence in the government could fall sharply, and other spending that relies on a functioning federal government could be postponed or cancelled.”

Standard & Poor’s, another ratings agency, previously forecast that the impasse cost $24 billion, or 0.6 percent of annualized GDP growth in the fourth quarter. A separate calculation done by the firm Macroeconomic Advisors suggests that crisis-mode policymaking has reduced U.S. economic output by as much as 1 percent annually over the past three years.

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