The US government has avoided a shutdown, but changing the fiscal trajectory requires tackling a sizable budget deficit, so fiscal policy should remain a friction point for the economy and markets.
The US Congress agreed on a short-term funding measure as September came to a close, heading off a government shutdown. The bill keeps the government running until November 17—just over a month from now—and ends the uncertainty that swirled as the debate raged. So, the shutdown has been avoided—for now—but it remains a possibility again when the stopgap measure expires.
A Spending Stopgap, but Fiscal Issues Run Deeper
However, more important than any short-term shutdown, in our view, is that a major change in the political climate would be required in order to address the US government’s long-term fiscal trajectory. Because that change seems unlikely, we expect fiscal policy to remain a friction point for the US economy and financial markets.
Make no mistake: avoiding a government shutdown is good news, because they cause hardship for many households, impede economic growth and rattle investors’ nerves. However, fiscal issues in the US run much deeper than a temporary shutdown. Budget deficits have remained unusually large in the post-COVID era, which is a break from the typical pattern. Usually, governments run large deficits during recessions and tighten fiscal policy during expansions.
A Surprising Problem with Declining Revenues
It's interesting that the deterioration in the budget deficit has more to do with government revenues than it does with government spending (Display). Yes, spending is up, but the real surprise is that government revenues are down, which doesn’t usually happen during an economic expansion.
That substantial revenue shortfall has widened the already sizable gap between spending and revenue. The Congressional Budget Office, which monitors the economy and budget, has produced forecasts that reflect a lasting budget deficit of around 6% of GDP for each year over the next decade, based on the current legislative landscape (Display).
What would it take to change that trajectory? Congress has to deliver some combination of spending reductions and revenue increases in order to whittle away at the deficit.
Given the areas where the government spends money, real change would likely require cutting spending on entitlement programs such as Medicaid, Medicare, Social Security, unemployment and welfare programs. And given where the government gets its revenues from, real change would require higher taxes. Neither appears to be under discussion right now, so Congress is essentially working around the margins of a large deficit rather than taking steps to make a more meaningful reduction.
Why Does a Chronic Budget Deficit Matter?
We don’t believe that rising government debt is likely to cause a crisis, but rising interest rates have made it much more costly to service that debt through interest payments (Display). With the Federal Reserve set to keep interest rates higher for longer and, in our view, rates likely to stay well above pre-pandemic levels, that bigger bill for the government won’t shrink any time soon.
The more money the government has to spend to service its outstanding debt, the less money it has available to spend on more productive things. And the next time the US economy does slow down meaningfully, it will cost a good deal more for the government to roll out the sort of fiscal support that typically helps bring recessions to an end.
All of this suggests to us that it’s critical for the government to address the bigger drivers of the budget deficit in order to change the country’s fiscal trajectory. So, avoiding a shutdown is a good start, but it isn’t enough to deal with the longer-term fiscal challenges the country faces.
- Eric Winograd
- Senior Economist—Fixed Income