What in the World is a Government Shutdown?

In yesterday’s edition of Piponomics, I discussed a few reasons why you shouldn’t panic about the looming debt ceiling deadline. After all, U.S. lawmakers have a knack for waiting until the last minute to come up with a battle plan to avoid default.

Right now, Republicans are insisting on more spending cuts and a repeal of the health care law while Democrats are refusing to budge. With less than a week away for lawmakers to get their act together, market watchers can’t help but worry about the potential effects of a government shutdown on the U.S. economy.

What the heck is a government shutdown anyway?!

Trusty ol’ Wikipedia defines a government shutdown as “a situation in which the government stops providing all but essential services” and it is up to the Office of Budget and Management to draw the line between essential and non-essential services.

Based on the past government shutdown during the Clinton administration in the mid-90s, services such as crime prevention, fire fighting, or weather forecasting, are likely to carry on while national parks and minor government agencies will probably be closed.

What could happen this time around?

Federal agencies haven’t revealed their plans yet but, if their 2011 proposals are any indication, less than 40% of federal employees would likely be forced to an indefinite, unpaid leave. Of course, the number of furloughed workers across each agency could be much lower or higher.

Workers who aren’t exempt from the shutdown will be paid, but often only after the shutdown is over. Those who are not exempt might not receive payments at all!

Meanwhile, any activity required to preserve the country’s banking and monetary system, such as tax collection and U.S. bond issuance, will still be continued.

What does this mean for the economy?

Analysts say that the impact on the economy depends on how long the government shutdown lasts. Still, the idea itself already discourages economic investments, contract renewals, and new hiring.

A prolonged shutdown could weigh heavily on business, investor, and consumer confidence. This is bad news for the U.S. economy, which is just starting to get back on the recovery road. It might also force the Fed to continue stimulating the economy.

Mark Zandi, chief economist and co-founder of Moody’s Analytics, estimates that a few days’ worth of shutdown would already cost the economy 2/10 of a percentage point in annualized growth.

It also doesn’t help that the potential shutdown could begin at a start of a fiscal quarter, in contrast to 2011’s shutdown around the middle of a quarter. If we do see a shutdown this time of the year, the markets could have a more difficult time making up for their losses until the end of 2013. Duhn duhn duhn duhn.

For now signs are pointing to an eleventh hour decision by the U.S. lawmakers, but if they continue to butt heads instead of coming up with a solution, then Uncle Sam might be in for a very shaky ride.