End of the shutdown doesn’t end the economic uncertainty it caused

After a 36-day saga, President Trump finally caved in to political pressures amid collapsing ratings and an impromptu Federal Aviation Agency shutdown of New York’s LaGuardia airport.

With the Senate swiftly passing a continuing resolution funding the government through Feb. 15 and President Trump signing the bill into law on Friday evening, the government is now open, and back pay will be provided to the 800,000 furloughed and unpaid federal workers affected by the longest government shutdown in history.

{mosads}But, while the government is once again open for business, we should not discount two lingering impacts. First, the loss of output, associated spending and persistent policy uncertainty as a result of the shutdown will not be recouped, leaving a permanent scar on the economy.

Second, the shutdown deprived private-sector economists and Federal Reserve policymakers of essential economic data on the state of the U.S. economy at a time when financial market stress and weakening global momentum made it essential to avoid being blindfolded. What will we discover when the blindfold is lifted?

Oxford Economics estimates that about 350,000 to 375,000 federal government employees were initially furloughed because of the partial federal government shutdown while another roughly 400,000 so-called “essential” workers were required to work without pay.

With several agencies, including the IRS, recalling workers in the last days of the shutdown, the number of furloughed workers fell closer to 300,000. Using federal pay and hours-worked data as a proxy for the lost output from furloughed workers, each week of government shutdown represented a direct output loss of $700 million for the U.S.

In annualized growth terms, this reduced real GDP growth by about 0.1 percentage point every two weeks. For federal workers working (and thus producing output) without pay, there is no direct loss of GDP, even though the longer the shutdown dragged on the more workers were calling in sick leading to indirect output losses.

Since the shutdown lasted through most of January, the direct drag on GDP growth in the first quarter (Q1) was just under 0.2 percentage points, with the indirect knock-on effects from reduced spending on services and heightened policy uncertainty bringing the total shock to just over 0.2 percentage points.

As such, Oxford Economics’ Q1 GDP growth forecast now stands at 1.8 percent, though admittedly we have little data on activity at the start of the year due to the government shutdown’s shuttering of key statistical agencies.

Importantly, the losses could have been exponentially steeper. First, as the shutdown dragged on, there was increased evidence of the hardships faced by unpaid government workers as well as federal contractors left without jobs.

Second, low-income families were particularly exposed given the potential shortfall in funding for low-income housing and food stamps. A one-month interruption of the funding for food stamps alone would have shaved GDP growth by around a half of a percentage point.

Factoring in the direct and indirect losses, Oxford Economics had estimated that a full quarter shutdown would’ve shaved 1.2 percentage points off GDP growth, reducing the pace of economic activity to its slowest in four years!

With the government open, we should put worries behind us, right? Not so fast! Congress and the president only approved a continuing resolution funding the government through Feb. 15, and the president has not waived the white flag on his battle for a border wall.

This means that we cannot discount renewed political tensions in three weeks. Further, it is very likely that political uncertainty will continue to weigh on federal workers and business leaders in the coming weeks, thus eroding otherwise solid economic momentum.

Unfortunately, neither private-sector economists nor Federal Reserve policymakers have had much visibility into the pace of economic activity since the end of 2018.

The recent economic data drought represents a dangerous blindfold at a time when volatile financial markets and slower global momentum made it more important than ever to have a good reading on the pulse of the economy.

Without data on trade, housing, business orders, personal income and consumer spending that was nearly impossible. The private- and public-sector data we did obtain was somewhat mixed with employment showing significant resilience, industrial activity maintaining a steady pace and confidence falling back to earth on more realistic expectations amid the shutdown.

A pause, prudence and patience for the Federal Reserve in 2019

This lack of economic data will favor a more cautious approach by the Federal Reserve as it attempts a soft-landing of the economy — a rare feat that would have been nearly impossible with a blindfold on.

Indeed, it was somewhat coincidental that a few weeks prior to the shutdown, Federal Reserve Chairman Jay Powell described the process of achieving neutral policy — one that is neither expansionary nor contractionary — as feeling your way in a “dark room full of furniture.”

We know from history that the process can be difficult even if you have previously seen the room lit, but imagine if you have absolutely no clue as to how the room looks.

The upcoming January Federal Open Market Committee meeting will feature the Federal Reserve’s first official statement and press conference of 2019.

{mossecondads}The statement and Chairman Powell’s ensuing remarks will reveal the “three P’s of 2019″: a pause in rate hikes along with monetary policy patience and prudence amid a soft global economic backdrop, convalescing financial markets and gradually released economic data in the wake of the shutdown.

This gradual approach will give the Federal Reserve the opportunity to assess the effects of tighter financial conditions on the economy, evaluate the impact of policy decisions (regarding trade and the government shutdown in particular) on activity and more broadly monitor the spillovers from slower global activity.

With financial markets being (overly) sensitive to policy developments, Powell will have to ensure that he weighs every word he utters and that he instills confidence in the economy while guaranteeing policy flexibility and empathy to market developments.

Gregory Daco is the chief U.S. economist for Oxford Economics.