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Government shutdown: How much will it harm the economy? (+video)

A government shutdown won't have much of an economic impact if it lasts just a few days, but a prolonged shutdown could become a drag on overall consumer and business confidence. 

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The effects of a debt-limit impasse could be severe for the US and the world, raising fears of a possible default by the US Treasury.

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Just the act of watching politicians dance near the brink was enough to cause a sizable fall in US consumer confidence and a downgrade of the US credit rating in 2011, the last time a debt-limit showdown occurred.

And stock markets around the world fell in tandem back then – a time when fiscal challenges were also weighing on European economies.

In the past week or so, US stock prices have traded generally downward, but not in a dramatic way.

The shutdown stems from a failure by Congress to agree on legislation to fund the government for a new fiscal year. Republicans are seeking to use the moment to gain leverage on everything from federal spending levels to – most prominently – their goal of thwarting the health-care reform law that President Obama signed in 2010.

It’s not really all of government that is closed. Operations deemed essential (such as national defense and air traffic control) continue, and so do programs that have funding that’s independent of Congress’s annual appropriations process. Social Security is a prime example.

But the effects are considerable still, because the federal government is America’s largest employer.

Some of the quickest effects are being felt in the Washington, D.C., area. Thousands of federal workers are staying home without pay, not frequenting local restaurants. The closure of museums and National Park sites ripples out to affect vendors of T-shirts and hot dogs. The shutdown could also put a damper for a time on what has been one of the nation’s hottest real estate markets.

But the shutdown’s effects go far beyond Washington.

Federal employees are in all 50 states, and a key channel of the shutdown’s impact is through the furlough of as many as 800,000 federal workers.

Federal employee compensation is considered GDP produced by the federal government, according to the forecasting firm IHS Global Insight in Lexington, Mass. The furlough of 774,000 workers – a number that assumes the same 36 percent share of the federal work force that was furloughed in 1995 – would result in a hit to GDP of 0.16 percentage points per week, the firm estimates.

Conversely, once a shutdown ends, much of the lost pay is expected to be restored. Such a down-and-up cycle in federal payrolls could all occur within the fourth quarter – helping to mute the shutdown’s impact on GDP.

But again, a long shutdown could become a drag on the overall confidence of US consumers and businesses – much like what occurred in that debt-limit debate of 2011.

“Consumer confidence, which has been trending down recently, would also be likely to suffer as consumers feel increasingly concerned about the government’s ability to avoid a self-inflicted wound,” writes Gregory Daco of Oxford Economics in New York.

Bottom line: The shutdown is a moment created by politicians, but it has at least some real economic consequences. If the consequences start looking more than modest, those politicians could quickly feel pressure to find a path out of their shutdown.

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