What’s happened?

The ideologically divided Republican majority in the House of Representatives (the lower house) has been unable to agree on annual appropriations bills needed to fund the US government when the current fiscal year ends at midnight on September 30th. Although last-minute negotiations are ongoing, we expect a government shutdown to begin on Sunday, halting all non-essential operations and causing thousands of workers to be furloughed.

Why does it matter?

For now we expect a shutdown to last a relatively brief one to two weeks. Existing economic fragilities—including a modest recent softening of the labour market, rising household financial strains and sky-high borrowing costs—will quickly intensify around this point, pressuring Congress to act. Brief shutdowns typically have only limited effects on the real economy, felt through a dip in consumer spending growth and lost revenue from closed services (such as tourism at national parks, which is unlikely to be made up later). This year, however, financial markets are likely to be affected more quickly, given existing market jitters. Long-term bond yields, which have already been pushed up by government policy risks in 2023, could climb even higher, pushing borrowing costs up and stock prices down.

The Republican speaker of the House, Kevin McCarthy, has several ways out of the current impasse, none of them good. In recent days he has proposed plans to cut discretionary spending by about 27% in 2024 (excluding the military and veterans’ affairs budgets). His proposal would also enact strict security measures along the US-Mexico border and exclude any new financial aid for Ukraine—priorities for some hard-right Republicans. For now, however, even these cuts appear insufficient to win over enough hard-right members to secure a majority in the narrowly divided (221-212) chamber. Even if they did, the measure has essentially no chance of passing the Senate (the upper house).

A second option would be to pass an appropriations bill with the support of House Democrats. However, some far-right members have threatened to challenge Mr McCarthy’s leadership should he make such a move. Given that he was elected speaker by a razor-thin majority and has had to battle for every policy win since then, it is unlikely that he is willing to take that risk unless as a last resort.

A third option would be for Mr McCarthy to seek agreement from his caucus on a stopgap spending measure, known as a continuing resolution, that would keep the government open for a month while efforts continued to find agreement on longer-term spending bills. Mr McCarthy also risks being ousted for such a move, making it unlikely in the coming days. However, if the shutdown drags on for more than a week and the negative economic effects start to build, this could become a more viable option.   

A longer shutdown would pose political challenges to both parties as the November 2024 elections loom, which supports our view that a solution will be reached within days or weeks. The Senate has already passed spending bills with bipartisan support; the bills are likely to go nowhere, which squarely places the blame for the current stalemate on hard-right House Republicans. If the shutdown drags on longer than we expect, this could hurt the already divided Republican voter base. Politically, Democrats have the most to lose. Economic conditions around the time of presidential election have an enormous impact on voter behaviour. We already expect conditions to deteriorate (albeit from a strong level) over the next six months. If business and consumer sentiment worsens more than we expect owing to a prolonged shutdown, the president, Joe Biden, is most likely to feel the brunt of voters’ frustration. 

What next?

We maintain our view that a shutdown will begin on October 1st, but that it will be fairly brief as members face up to the economic and political costs of a prolonged shutdown. Our existing forecast includes a slight GDP contraction in the fourth quarter, of 0.4% (in quarter-on-quarter, annualised terms), followed by modest growth in the first half of 2024, as household financial strains curb consumer spending. A short-lived government shutdown is unlikely to influence our economic forecasts, but a longer one would push our GDP forecast lower, potentially down by 0.2 percentage points in the fourth quarter. 

The analysis and forecasts featured in this report can be found in EIU’s Country Analysis service. This integrated solution provides unmatched global insights covering the political and economic outlook for nearly 200 countries, enabling organisations to identify prospective opportunities and potential risks.