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Yves here. We have been publishing more and more informing of deteriorating fundamentals in the US (and Europe and even in China), debt blowups in unexpected places and rising investor worries about more defaults, and AI manis-driven stock valuations. The deteriorating conditions (ex the almost certainly self-limiting AI froth) are coming despite years of running the US economy at unsustainably hot levels due to huge Biden and now Trump fiscal deficits. And Trump’s toadies do not even remotely have the chops to handle a financial crisis.
By John W. Diamond, Director of the Center for Public Finance at the Baker Institute, Rice University. Originally published at The Conversation
The economic consequences of the current federal government shutdown hinge critically on how long it lasts. If it is resolved quickly, the costs will be small, but if it drags on, it could send the U.S. economy into a tailspin.
That’s because the economy is already in a precarious state, with the labor market struggling, consumers losing confidence and uncertainty mounting.
As an economist who studies public finance, I closely follow how government policies affect the economy. Let me explain how a prolonged shutdown could affect the economy – and why it could be a tipping point to recession.
Direct Impacts from a Government Shutdown
The partial government shutdown began on Oct. 1, 2025, as Democrats and Republicans failed to reach a deal on funding some portion of the federal government. A partial shutdown means that some funding bills have been approved, entitlement spending continues since it does not rely on annual appropriations, and some workers are deemed necessary and stay on the job unpaid.
While most of the 20 shutdowns that occurred from 1976 through 2024 lasted only a few days to a week, there are signs the current one may not be resolved so quickly. The economy would definitely take a direct hit to gross domestic product from a lengthy shutdown, but it’s the indirect impacts that could be more harmful.
The most recent shutdown, which extended over the 2018-2019 winter holidays and lasted 35 days, was the longest in U.S. history. After it ended, the Congressional Budget Office estimated the partial shutdown delayed approximately US$18 billion in federal discretionary spending, which translated into an $11 billion reduction in real GDP.
Most of that lost output was made up later once the shutdown ended, the CBO noted. It estimated that the permanent losses were about $3 billion – a drop in the bucket for the $30 trillion U.S. economy.
The Indirect and More Lasting Impacts
The full impact may depend to a large extent on the psychology of the average consumer.
Recent data suggests that consumer confidence is falling as the stagnation in the labor market becomes more clear. Business confidence has been mixed as the manufacturing index continues to indicate the sector is in contraction, while other business confidence measures indicate mixed expectations about the future.
If the shutdown drags on, the psychological effects may lead to a larger loss of confidence among consumers and businesses. Given that consumer spending accounts for 70% of economic activity, a fall in consumer confidence could signal a turning point in the economy.
These indirect effects are in addition to the direct impact of lost income for federal workers and those that operate on federal contracts, which leads to reductions in consumption and production.
The risk of significant government layoffs, beyond the usual furloughs, could deepen the economic damage. Extensive layoffs would shift the losses from a temporary delay to a more permanent loss of income and human capital, reducing aggregate demand and potentially increasing unemployment spillovers into the private sector.
In short, while shutdowns that end quickly tend to inflict modest, mostly recoverable losses, a protracted shutdown – especially one involving layoffs of a significant number of government workers – could inflict larger, lasting impacts on the economy.
US Economy Is Already in Distress
This is all occurring as 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 growth of only 73,000 in July, with May and June estimates revised down by 258,000. In addition, preliminary annual revisions to the employment data show the economy gained 911,000 fewer jobs in the previous year than had been reported.
Long-term unemployment is also rising, with 1.8 million people out of work for more than 27 weeks – nearly a quarter of the total number of unemployed individuals.
At the same time, AI adoption and cost-cutting could further reduce labor demand, while an aging workforce and lower immigration shrink labor supply. Fed Chair Jerome Powell refers to this as a “curious kind of balance” in the labor market.
In other words, the job market appears to have come to a screeching halt, making it difficult for recent graduates to find work. Recent graduate unemployment – that is, those who are 22 to 27 years old – is now 5.3% relative to the total unemployment rate of 4.3%.
The latest data from the ADP employment report, which measures only private company data, shows that the economy lost 32,000 jobs in September. That’s the biggest decline in 2½ years. While that’s worrying, economists like me usually wait for the official Bureau of Labor Statistics numbers to come out to confirm the accuracy of the payroll processing firm’s report.
The government data that was supposed to come out on Oct. 3 might have offered a possible counterpoint to the bad ADP news, but due to the shutdown BLS will not be releasing the report.
Problems Fed Rate Cuts Can’t Fix
This will only increase the uncertainty surrounding the health of the U.S. economy. And it adds to the uncertainty created by on-again, off-again tariffs as well as the newly imposed tariffs on lumber, furniture and other goods.
Against this backdrop, the Fed is expected to lower interest rates at least two more times this year to stimulate consumer and business spending following its September quarter-point cut. This raises the risk of reigniting inflation, but the cooling labor market is a more immediate concern for the Fed.
While lower short-term rates may help at the margin, I believe they cannot resolve the deeper challenges, such as massive government deficits and debt, tight household budgets, a housing affordability crisis and a shrinking labor force.
The question now is not will the Fed cut rates, because it likely will, but whether that cut will help, particularly if the shutdown lasts weeks or more. Monetary policy alone cannot overcome the uncertainty created by tariffs, the lack of fiscal restraint, companies focused on cutting costs by replacing people with technology, the impact of the shutdown and the fears of consumers about the future.
Lower interest rates may buy time, but they won’t solve these structural problems facing the U.S. economy.
aye. anecdata from my cousin in north houston exurbia confirms all of this.
he’s been a construction guy all his life..now shotcaller/contractor/big boss.
he says his fone is regulary blowing up with people who’ve worked for him before, calling and begging for work…but there aint none.
and in addition to all of the above in this article, theres an ongoing weirdness with the insurance companies(a lot of his work used to derive from insurance payouts).: they are slower than ever to pay up when theres a claim…so the work cant even begin…so pmc types living in hotels, or sometimes under the big tarp where their roof used to be.
he says the panic and fear among the people is palpable…like a giant rubber band stretched taught in the ether.
The slow payouts by insurance companies really seem to impact how communities are or aren’t rebuilt after a disaster. By the time the payout comes (sometimes four years later, after site remediation), it won’t cover the increase in building cost between the claim date and payout date. Many insured owners have to pay the difference out of pocket, sometimes hundreds of thousands of dollars, or walk away. If they want to rebuild a smaller, more affordable house, it probably won’t be covered.
Meanwhile, US tariffs on BC lumber will soon add up to 45%.
I always go with Doug Fir, regardless of the insurance.
Given the givens, things are an order of magnitude worse than they were during the last shutdown. That was in the Before Times. The stock market wasn’t balanced on a pin named Nvidia, there wasn’t an ongoing genocide, the techbros weren’t in the Oval Office, we’re up another five percent on CO2 levels…
An order of magnitude longer shutdown would about put us to the mid-terms. Megafarms were built on buying land at ten cents on the dollar after the Depression, and we have layers of tight coupling accreted since then. Opportunity for Accelerationists.
Not saying it will happen, but it’s on our matrix of possibilities. Avoid ruin.
From the 4th link provided I suspect that Democrats will probably loose sooner or later the political pulse with defections on their side. Is this an existential problem for the party? Not that I care very much about the democrats but the libertarians will probably feel emboldened to do whatever they wish and this is not good news for the US frankly. Neither for the ROtW. The MSM is so far unable to admit that the US is now a rogue country but evidences are mounting fast. Is there any hope to stop or pause the process?
Restoring DemParty control over Federal government wouldn’t fix anything, but it would buy a few years of semi-peace for nonMaga nonDemocrats to do their own parallel political organizing, cultural organizing, new political party-movement organizing, etc. for survival over the near and mid time horizon, and then eventual reconquest of America and perhaps even functional extermination-from-existence of Magapublican culture and politics from any trace of power or influence anywhere in America.
And failing that, at least the achievement of intensive deep-cleansing deMagafication of enough contiguous Blue States that they could all survive separately as a collection of contiguous-bordered Blue States preparing for Velvet Divorce or Velvet Stealth Secession or at least surviving and outliving a much-to-be-desired utter collapse of Deep Maga Red State America.
Dang. What part of the DemParty is worthy of restoration? And define control over the Federal Govt. What part of parallel… organizing are you seeing? OMG, reconquest of America, and extermination??? You are seeing DemPower and I am seeing nothing. Zero. And that’s just the first paragraph.
The second paragraph captures the insanity of the Blue States. Intensive deep-cleansing, survive separately, surviving and outliving. Perfectly rational insanity, I believe.
I’m half with you. I just don’t know which half. I really don’t like my choices. Or yours.
Sometimes all we are given is Hobson’s Pastry Tray and told to choose.
What part of the DemParty is worthy of restoration? Well . . . if Mamdani gets elected Mayor of New York and works to decontaminate all the Clintobamas and bipartisan cucks out of the citywide DemParty structures and membership rosters . . . . is that particular part of the DemParty worth having reconquered, declintaminated and restored? As an example?
Some “Blue” states are the size of respectable little countries. A Blue States of America would be the size of a respectable mid size country. Could a Blue State Survival-load of people work to tighten inter-Blue-State transportation, source more and more and then all food for Blue State non-farmers from Blue State farmers within Blue States, etc.?
If the alternative looks like permitting the Maga movement to conquer and degrade Blue States down to Maga levels, will an attempt at separate survival look less insane to you than it does now? I hear there is already a ( for now) satirical movement on the part of some people in California-Oregon-Washington to petition Canada to allow these three Pacifican states into Canada as Canadian provinces. Would that be insane if it became serious?
Dang. What part of the DemParty is worthy of restoration? And define control over the Federal Govt. What part of parallel… organizing are you seeing? OMG, reconquest of America, and extermination??? You are seeing DemPower where I am seeing nothing. Zero. And that’s just the first paragraph.
The second paragraph captures the insanity of the Blue States. Intensive deep-cleansing, survive separately, surviving and outliving. Perfectly rational insanity, I believe.
I’m half with you. I just don’t know which half. I really don’t like my choices. Or yours.
Weird stuff happened. sorry for the second post.
Could it be said that the USA, just looking at total population over its history, has done more with less? With that possibility, I’m left in wonder at some of the metrics.
As I’m just waking, a couple of big picture issues off-the-cuff:
1) Misallocation of resources (including too much bubble blowing)
2) Too much worrying about shit that hasn’t happened to people who aren’t here
Since the middle of last year, the federal reserve has cut interest rates by 1.25% total, but 30-year mortgage rates are still in the 6.5% range. That’s quite remarkable. Remarkably bad but still. If the bond market was still responding to the Fed in a historically standard pattern, the 30-year rate would be in the 5.00-5.50% rate.
Mortgage rates will not drop until inflation does. The bond market is responding to inflation rationally. If yields dont beat inflation, no one buys the bonds.
What is the duration of the financial instruments they cut?
I lost my full-time job this week. One year after I lost my part-time job. Talked to my former co-workers at my part-time restaurant job. Their pay was down 40% from a few years ago. My full-time job was back to 2016 levels of sales after almost a 200% increase during COVID. My wife’s friend and her husband do freelance work for advertising companies. They pay $1,200 a month for their health insurance. If Republican plan goes through, it will go up to nearly $3,500. Two of my other friends are underemployed and borderline soon to be unemployed. One worked as a nonprofit consultant and other construction. My family’s auto repair shop has been slow as well. Hard times and getting harder