The economic consequences of a government shutdown can’t be calibrated on a spreadsheet with an economic model. It all depends on who wins public opinion – congressional Republicans or the president and Democrats.
Federal spending is out of control. From 2007, the last full year before the financial crisis, to 2011, the second full year of economic recovery, spending has jumped $1.1 trillion – 40 percent, when only a $200 billion increase would have kept pace with inflation.
For any other country, a deficit exceeding 10 percent of GDP would force austerity by sending interest rates on government bonds through the roof. Alas, the United States prints the world’s currency – the dollar – so it can inflate its way to solvency, and the bond market is starting to take that bet.
Enter the tea party – that troublesome bunch of youngsters pushing elder Republicans to stand up for fiscal solvency, end the madness, or halt funding for the government.
Closing federal offices for a few days will have not a great, lasting impact. On reopening, the checks will go out. What counts, though, is whether the newly elected conservative majority in the House of Representatives keeps its mandate as measured by the polls.
Republicans don't have all the answers
Through 2022, the projected cumulative deficit is $11 trillion, and House Republicans have just released a plan to cut that figure by roughly $6 trillion over the next decade.
But the means for getting there are hardly attractive – vouchers for poor folks to purchase health care and block grants to the states to replace and reduce much of federal Medicare spending. That would morph President Obama’s vision of universal coverage into a victimization plan for the poor and even bigger budget crises for the states.
Americans pay too much for health care, spending 18 percent of GDP for less effective service than the Germans and Dutch receive spending only about 12 percent of GDP. Instead of taking on higher US drug prices, bloated health insurance and hospital administrative costs, and malpractice abuse, Republicans will tell the poor and the states to bargain with the big guys directly. Good luck with those ideas.
As for Social Security – hush, Republicans have a secret plan! The GOP will save money but so far has not revealed how. Private investment accounts, the favorite among free marketeers, would leave brokers smiling but the old poorer, judging by how most IRAs have faired since 2000.
Of course, if the president comes out of the government shutdown politically stronger, then its business as usual. But can it be?
Can't go back to business as usual
Thanks to huge deficits, inflation expectations are rising, and bond investors are becoming wary that the secular trend on 20- and 30-year US Treasury rates is up and up. That’s not just a cyclical adjustment this summer, as unemployment falls and the Federal Reserve ends quantitative easing. Rather, the upward trend is happening in large part because federal deficits in coming years are expected to be much larger than what President Obama's budgets project. He assumes too much cost savings and additional revenue from health-care reforms, and a 4 percent growth rate for the next four years, which few economists would endorse.
As the long rate on Treasuries rises, interest payments will absorb more and more federal revenue, and austerity will be foisted on the US government in the manner of Greece or Portugal. At that point, slashing as opposed to reason will prevail. Thoughtful reforms in health care and for Social Security become even more difficult.
The choices are clear. Congress must make responsible reforms to health care that harness drug, administrative, and tort costs now, and ensure solvency for Social Security by raising the retirement age to 70, or the bond vigilantes will ultimately end the party. Then more draconian changes will be forced on the American people who simply refuse to live within their means.