The Weird Reason Shutting Down Government Will Boost Growth

Photograph by Rainer Ebert/Getty Images

Economists don’t see the world the way real people do. Proof: Ever since the federal government shutdown began, economists have been raising their forecasts for first-quarter growth.

How can that be? Isn’t the shutdown, like, bad for the economy? Of course. But unless the confrontation really drags on, it will suppress the economy’s output only in the current quarter ending Dec. 31. Output should be back to normal in the January-March quarter. Since economists calculate growth by comparing the level of output in one quarter to the previous quarter, a rebound back to the baseline in the first quarter of 2014 will register as a burst of growth. Strange, right?

Actually, it’s weirder than that. Economists “annualize” the quarterly change in output. In calculating the economy’s growth rate, they assume the rate of change in one quarter will persist for a full year, even if they know it won’t. This exaggerates the impact of one-shot events such as the shutdown. Keep this in mind when you read news stories about the impact of the government shutdown.

Today, for instance, Goldman Sachs estimated that the shutdown would suppress the economy’s annualized growth rate by about 0.2 percentage points if it were to last one week and 0.4 percentage points if it lasted two weeks. But the worse the decline in the fourth quarter, the better the first quarter will look: Goldman predicts “a positive effect of the same magnitude in Q1 as federal spending returns to its non-shutdown level.”

The biggest hit to growth from the shutdown comes from a decline in pay to federal workers, which is counted as “consumption” by the federal government in the national accounts. If Congress decides to make up all the lost pay to federal workers later in the fourth quarter, the measured hit to economic growth in the quarter as a whole would be virtually zero. But imagine that Congress doesn’t get around to making up federal workers’ pay until, say, January. Then you’d see an even bigger boost to the first quarter—entirely artificial, of course.

A funny property of percentages is that if your output falls by half and then goes right back to where it was, you get a 50 percent decline followed by a 100 percent rise, creating the false impression that you’re ahead of where you started. That phenomenon could work on a smaller scale if there’s any spending catch-up in the coming quarter. Imagine that federal spending drops 5 percent in the current quarter and then is entirely made up to start 2014. That would show up as an annualized rate of decline of a little under 19 percent in this quarter, followed by a rise of nearly 23 percent next quarter. Actual spending increase in that scenario: zero.

Math can’t solve for the most important variables in the growth equation, such as when the shutdown will end, how it might affect confidence in the broader economy, and whether the U.S. will default when it hits the debt ceiling in a couple of weeks. For that, bring in the psychologists.

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