US Economics | October 2, 2013
October 2, 2013
Morgan Stanley & Co. LLC
Vincent Reinhart
US Economics
[email protected]
12 Things You Want to Know About the
Shutdown and Debt Ceiling
+1 212 761-3537
Ellen Zentner
[email protected]
+1 212 296-4882
Ted Wieseman
[email protected]
+1 212 761-3407
Dane M Vrabac
You asked and we answered: a list of the top 12
questions our clients have asked about the
government shutdown and upcoming debt ceiling
debate. Our responses follow.
[email protected]
+1 212 761-1929
John Abraham
[email protected]
+1 212 761-5629
For important disclosures, refer to the Disclosures Section, located at the end of
this report.
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US Economics | October 2, 2013
What is the shutdown's potential drag on GDP?
Bottom line: For every week of shutdown, we estimate a direct effect of approximately a 0.15 percentage
point (pp) reduction to quarterly GDP growth.
How we arrived at this answer: About 20% of real federal spending and 1.5% of GDP is devoted to the
compensation of nondefense federal government employees and civilian employees within the defense
department. GDP is a measure of final output and therefore excludes intermediate inputs that go into the
production of final output. But specifying and measuring units of exactly the goods and services being
provided by the government for consumption by the public is not conceptually straightforward. Hence, for a
good deal of government spending there's an exception to the standard way of translating its contribution to
GDP: inputs (like the compensation of government employees) are included, with an assumption of zero
productivity, and used directly to measure output.
Take 1/3 of the 1.5% of GDP that represents the furloughed pay of “non-essential” non-military employees
(roughly 2/3 will keep working because they deal with national security or otherwise protect life and property
so are deemed “essential”) and the resulting 0.5% of GDP goes to zero in a shutdown. Take that 0.5% of
GDP, divide by the 13 weeks of a quarter, then annualize the impact to a quarterly growth rate, and you get
an approximate 0.15pp direct arithmetic hit to quarterly GDP growth for every week of shutdown.
Impact on 4Q13: Overall we expect the Q4 GDP impact to be relatively small, but it’s impact will depend
on how long the shutdown lasts. Those employees who are deemed essential are guaranteed backpay and
those who are non-essential may be paid as well. In the 1995-96 shutdown (that lasted 21 days), all
employees (essential and non-essential) were given back pay. So the hit to nominal GDP is likely to be made
up this quarter as well. For real GDP, which is based on the number of hours worked, not the compensation
received, there will be a -0.15pp hit per week of shutdown. Our expectation has been that this shutdown will
last the better part of one week, but there is no guarantee.
The indirect effect of a government shutdown is much more difficult to measure. How businesses respond via
reduced investment and how households respond via slower spending will be key and will be heavily
influenced by the duration of the shutdown.
Do we expect any carry-over in 2014? There will be some reversal in Q1 2014 of a Q4 hit to GDP as
furloughed workers revert back to 13 weeks of pay from 12 in the case of a one-week shutdown, but there’s
still permanent lost output because the missing week of work will not be recouped. Effects get bigger than
just that direct impact of lower paychecks should the shutdown last longer and perhaps lead to a softer job
market.
Will there be disruptions to the CPI data collection and report?
Bottom Line: Most likely.
Historically, there have been disruptions to CPI surveys and reports during government shutdowns. As the
Bureau of Labor Statistics (BLS) states on its website: During the shutdown the BLS will not collect data,
issue reports or respond to public inquiries.
What happened last time? The BLS discussed the shutdown in impacted reports. In short, the agency
filled in the missing surveys when they could, so there may have been some timing issues impacting the
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US Economics | October 2, 2013
survey results. In particular for the January 1996 report, the BLS noted that it had to fudge the misaligned
survey periods and was unsure how that may have impacted the reported results. Later analysis did not find
clear evidence that the CPI data were compromised.
Excerpts from actual reports
November 1995 CPI release
As the Bureau of Labor Statistics announced on November 21, the CPI for November, originally
scheduled for release December 13, was rescheduled for release on December 14. Price collection in
November was extended beyond the usual closeout date in order to obtain those price data that were
lost during the period from the 14th through the 19th of November, when CPI data collection was
suspended as a result ofthe federal government shutdown.
December 1995 CPI release
As previously announced, the Consumer Price Index for December 1995, originally scheduled for
release on Jan. 12, was rescheduled for release on Feb. 1. Price data collection in December, which
was originally scheduled to conclude on Dec. 21, was suspended on Dec. 18, 1995 as a result of the
federal government shutdown. In anticipation of a possible shutdown, BLS had modified the December
pricing schedule to allow for somewhat earlier collection than normal. This resulted in virtually
complete pricing for the December index; the number of price quotes collected and used in the CPI for
December 1995 was approximately 98 percent of the corresponding number for December 1994.
The shutdown also affected the collection and release of the January 1996 CPI. The January index,
originally scheduled for release on Feb. 14, will now be released on Feb. 28. In January, the scheduled
collection of consumer price data would have begun on Jan. 2 and concluded on Jan. 26. The revised
schedule allowed for pricing through Jan. 31. No data were collected prior to the reopening of the
government on Jan. 8, and much collection could not begin until January pricing schedules were
transmitted from Washington, D.C., to BLS field offices. Additional delays were caused by the blizzard
that forced the closing of many retail outlets and BLS offices during the week of Jan. 8. Therefore, most
January price collection took place between Jan. 15 and Jan. 31.
The shutdown will have a relatively minor effect on the collection of consumer price data in February,
and the CPI for February is expected to be released as originally scheduled on March 15.
How long do we expect the shutdown to last?
Bottom Line: In keeping with historical experience, our initial assessment is that this shutdown will be over
within a week.
Although it's not clear who will blink first in the ideological standoff, as time goes on, heat will build on
representatives from constituents who were furloughed, inconvenienced, or fearful of market consequences.
In the table of past shutdowns (see How many times has this happened before?), the average duration of
the past 17 shutdowns has been 6 days, with a median of only 3 days.
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US Economics | October 2, 2013
Having said that, polarization in Congress has increased dramatically over the past three decades, so
experience may not provide much of a guide about the timing of either party's willingness to give
concessions. Further, although both parties are gearing up for the midterm election cycle, recent poll results
suggest both parties are gaining confidence that blame can be parried.
To see what investors and clients thought, in a survey we asked how long they expect the shutdown to last.
We were somewhat surprised to find out that, out of nearly 400 respondents, 47% expected the shutdown to
last longer than a week, 36% between 4 and 7 days, and only 17% 3 days or less.
Exhibit 1: How long do you think the government shutdown will last?
Source: Morgan Stanley Research
Will the Employment Report be released this Friday (Oct 4)?
Bottom Line: Probably not.
Unlike other economic releases the Bureau of Labor Statistics works on the establishment survey results up
until the morning of the publication. As of now, progress on compiling the data has halted, as the BLS is
operating with only 3 out of its typical work force of nearly 2,500. If no resolution is made by Thursday
morning, the data release will be delayed.
The last time the employment report was postponed was during the 1995-96 shutdowns. Specifically, the
report for December 1995, originally scheduled to be released on January 5, 1996 was delayed until January
19 (note: the only other instance in recent memory in which the employment report was not released on the
scheduled date was in November 1998 when the report was released a day early because some of the data
had been inadvertently posted on the BLS web site).
If the employment report is not released on Friday, when will it be ready?
The BLS will likely need a day or two after the government reopens to finish its calculations and release the
jobs report. Note that the household survey tabulations were probably almost complete as that survey is
conducted earlier than the establishment survey, but as noted above, the establishment survey will require
more work. In sum, we expect the employment situation report to be released a full two days after the
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US Economics | October 2, 2013
government reopens. The BLS will no doubt send out a press released with an updated data release
schedule not long after resuming activities.
How is the Debt Ceiling debate related to the shutdown?
Bottom Line: The budget debate and the looming debt ceiling are two distinct issues: the former is related
to appropriations authority and the later pertains to debt issuance authority.
Since early summer, the US Treasury has been using “extraordinary measures” to fund the US government.
If, as estimated by Secretary Lew and in line with our projections, the Treasury runs out of extraordinary
accounting adjustments that make room for marketable borrowing on October 17 (the so called “X
date”), they will be left with $30 billion in cash on hand, which will be enough to last until month
end. Inflows and outflows from October 17 to 31 should be moderate and only gradually work down the
starting $30 billion cash balance. But there’s no way there would be enough money available on November 1
to pay out $24 billion in Social Security benefits, $18 billion in Medicare reimbursements, and another $25
billion or so in other 1st of the month payments for veterans benefits, civil service pensions, military pay, SSI
benefits, etc. A debt ceiling increase will have to be in place for Treasury to move forward with heavy net
issuance that should occur on October 31 (a scheduled weekly T-bill settlement day in addition to month-end
settlement of the 2-year, 5-year and 7-year auctions) in order to have enough cash on hand to make those
payments. If we get close to the deadline and no increase in the debt limit is yet in place, the
Administration’s trump card could end up being an official announcement that November 1 Social Security
benefit checks have to be canceled because of Congressional inaction on the debt ceiling, which would likely
bring overwhelming public pressure to get a deal done immediately.
There has been a good deal of public and media confusion surrounding the approaching funding deadlines.
As Secretary Lew notes in his letter to Congress, October 17th is the date when “extraordinary measures will
be exhausted” and the Treasury will run out of borrowing capacity – this is not the date the Treasury
will run out of cash. We expect that the $30 billion in cash they have will last until November
1st, when several large program expenditures are scheduled. While on one hand this gives politicians more
time to strike a deal, on the other it also means they have more time for political gamesmanship (ping pong,
anyone?). Nonetheless, we believe there is a zero percent chance of a federal government
default at that time. The US government will pay its bills.
How many times has this happened before?
Many - there have been 17 government shutdowns since 1976.
Historically, government shutdowns last only a few days (most have been 1 to 3 days), but the most recent
lasted 21 days over the end of 1995 into 1996.
Exhibit 2: Past Government Shutdowns
Dates
# of Days
September 30 to October 11, 1976
10
September 30 to October 13, 1977
12
October 31 to November 9, 1977
8
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US Economics | October 2, 2013
November 30 to December 9, 1977
8
September 30 to October 18, 1978
18
September 30 to October 12, 1979
11
November 20 to November 23, 1981
2
September 30 to October 2, 1982
1
December 17 to December 21, 1982
3
November 10 to November 14, 1983
3
September 30 to October 3, 1984
2
October 3 to October 5, 1984
1
October 16 to October 18, 1986
1
December 18 to December 20, 1987
1
October 5 to October 9, 1990
3
November 13 to November 19, 1995
5
December 15, 1995 to January 6, 1996
21
Average
6
Median
3
Maximum
21
Source: Morgan Stanley Research
Where can I find further details on previous shutdowns?
We recommend two places:
Congressional Research Service (here)
Shutdown of the Federal Government: Causes, Processes and Effects
Government shutdowns have necessitated furloughs of several hundred thousand federal employees,
required cessation or reduction of many government activities, and affected numerous sectors of the
economy. This report discusses the causes, processes, and effects of federal government shutdowns,
including potential issues for congress.
The Washington Post's Wonkblog (here) article by Dylan Matthews (Sept 25, 2013)
Here is every previous government shutdown, why they happened and how they ended
The title says it all.
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US Economics | October 2, 2013
What effect with there be on data releases?
Bottom Line: Most government data will not be released, all privately sourced reports will be released.
The schedule below runs through the end of next week. This is not our call, but we want you to be informed
if it happens. Our full 2 week calendar (Sept 30 - Oct 11) can be found here.
Will be released
Week of Sep 30 - Oct 1
ISM
Motor Vehicle Sales
ADP Survey
Jobless Claims (the BLS has indicated the claims reports will be released each week)
Challenger Survey
ISM Non-manufacturing
Week of Oct 7 - Oct 11
Consumer Credit
NFIB Survey
FOMC Minutes
Jobless Claims (the BLS has indicated the claims reports will be released each week)
University of Michigan Consumer Confidence Index
Will not be released
Week of Sep 30 - Oct 1
Construction Spending
Factory Orders
Employment Situation
Week of Oct 7 - Oct 11
Trade balance
Wholesale Trade
Import/Export Prices
Retail Sales
Producer Price Index
Business Inventories
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US Economics | October 2, 2013
What happens to Federal government benefits?
Bottom Line: Social security, unemployment insurance and foodstamps will continue.
Social Security is considered a mandatory spending program. Unemployment insurance will continue to be
paid since funds are available and are not funded with expired annual appropriations. The Department of
Labor stated, “Current circumstances are different from 1995 when we were not paying Emergency
Unemployment Compensation or full Federal funding for Extended benefits.” Foodstamps (Supplemental
Nutrition Assistance Program) are funded through the Recovery Act and do not expire until the end of
FY2014.
How will essential and non-essential employees be compensated?
Bottom Line: Excepted or “Essential” employees are guaranteed back payment, non-excepted or “nonessential” employees are not.
During the government shutdown, authorization to pay all federal employees is suspended. When the
stalemate ends and Congress passes a continuing resolution, however, all excepted (or “essential”)
employees are guaranteed retroactive payment. No guarantee is in place for non-excepted employees.
Instead, Congress must specifically authorize back payment for all furloughed workers. Note however in the
last government shutdown from December 15, 1995 to January 6, 1996, Congress agreed to pay all
employees (excepted and non-excepted). As soon as a continuing resolution is approved, all employees are
likely to receive payment for missed time, but there is no guarantee for non-essential employees.
Can furloughed gov. employees claim unemployment insurance?
Bottom Line: In some cases, yes.
If the shutdown lasts longer than two weeks, non-excepted employees may begin to file for unemployment
insurance. Excepted employees may not. However, if beyond that point, if Congress does pass a continuing
resolution that includes a provision for retroactive payment for non-excepted employees, then those
employees who received unemployment benefits must return any money received.
Does a last resort option exist to save the US from default?
Bottom Line: Yes, but it will break one of three laws.
If the Treasury is unwilling to stretch the definition of extraordinary measures, on the day that the Federal
Reserve predicts that the Treasury will run out of cash in its account and the Treasury is bound by the debt
ceiling, it should pend all payments and await instructions from the Treasury.
As a result, all principals will face the prospect of violating one of three laws:
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US Economics | October 2, 2013
1. The Second Liberty Bond Act of 1917 that establishes the debt ceiling;
2. The Federal Reserve Act that prohibits the Fed from lending directly to the Treasury; or,
3. The 14th Amendment of the Constitution that holds that the debt of the US government, lawfully
issued, will not be questioned.
They have to break a law. Full stop. We think at the end of the day officials will avoid violating the
Constitution by indicating that they have been given inconsistent instructions and are obeying the one with
the most important precedent.
If it is the Secretary of Treasury that decides to contest 1, then the Treasury will issue debt and raise cash.
However, the debt arguably does not have the protection of Amendment 14, as it was not necessarily
lawfully issued, so it may not be default free. That is, in the European context, the Treasury will issue “red”
bonds in order to pay the maturing principal and interest on “blue” bonds. The reds turn blue when the debt
ceiling is increased.
If it is the Chairman of the Federal Reserve that decides to contest 2, then the Treasury General Account
(TGA) goes into overdraft and all Treasury operations continue.
Either a Secretary of Treasury who holds 3 as the overriding instruction or a Chairperson of the Federal
Reserve who waves 2 saves the global financial system and at most risks being impeached or fired. That
seems like a reasonable risk and reward trade-off. The government of the United States is not going to
default.
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US Economics | October 2, 2013
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