Yves here. We’ve been sharing increasingly concerning insights regarding the weakening economic fundamentals in the U.S., Europe, and even China. There are rising fears among investors about potential debt crises in unexpected areas, coupled with inflated stock valuations driven by AI mania. Despite years of pushing the U.S. economy to unsustainable extremes due to immense fiscal deficits under both Biden and Trump, these troubling conditions are unfolding. Even more concerning is the lack of expertise among Trump’s allies when it comes to managing a financial crisis.
By John W. Diamond, Director of the Center for Public Finance at the Baker Institute, Rice University. Originally published at The Conversation
The Potential Fallout of the Federal Government Shutdown
The economic ramifications of the current federal government shutdown critically depend on its duration. If resolved promptly, the impact will be minimal, but an extended shutdown could push the U.S. economy into a precarious position.
Currently, the economy is already fragile, with a struggling labor market, decreasing consumer confidence, and an increasing sense of uncertainty.
As an economist specializing in public finance, I closely monitor the effects of government policies on the economy. Here’s how an extended shutdown could influence the economic landscape and serve as a potential catalyst for recession.
Immediate Effects of a Government Shutdown
The partial government shutdown began on October 1, 2025, after Democrats and Republicans failed to reach a funding agreement for part of the federal government. In this scenario, some funding bills have been approved, entitlement spending continues unimpeded, and certain workers are required to work without pay.
While most of the past 20 shutdowns between 1976 and 2024 lasted only days to about a week, indications suggest that this shutdown may persist for longer. A lengthy shutdown would certainly inflict a direct downturn on gross domestic product, but its indirect repercussions could prove to be even more damaging.
The most recent shutdown, which occurred over the 2018-2019 holiday season and lasted for 35 days, marked the longest in U.S. history. Following its conclusion, the Congressional Budget Office estimated that approximately $18 billion in federal discretionary spending was delayed, resulting in an $11 billion reduction in real GDP.
While the majority of that lost output was recovered after the shutdown ended, the CBO noted that the permanent losses amounted to about $3 billion—an insignificant sum for the $30 trillion U.S. economy.
Longer-Lasting Indirect Consequences
The full impact of the shutdown may largely depend on consumer psychology.
Recent data indicates that consumer confidence is waning as labor market stagnation becomes increasingly apparent. Business confidence is also mixed; while the manufacturing index indicates contraction, other measures of business confidence reflect uncertain expectations for the future.
If the shutdown continues, psychological effects may lead to a significant decline in confidence among both consumers and businesses. Given that consumer spending accounts for 70% of economic activity, a decrease in consumer confidence could mark a pivotal moment for the economy.
These indirect outcomes build on the immediate loss of income for federal workers and those in federal contracts, resulting in declines in both consumption and production.
Moreover, extensive government layoffs, beyond typical furloughs, could exacerbate economic damage. Such layoffs would shift losses from a temporary delay to a more sustained loss of income and human capital, causing a decrease in aggregate demand and potential spillovers of unemployment into the private sector.
In summary, while quick shutdown resolutions typically yield modest and mostly recoverable losses, a prolonged shutdown—particularly one involving substantial layoffs—could result in more significant and enduring effects on the economy.
The U.S. Economy’s Distress Signals
All of this is taking place against the backdrop of a labor market that is sending alarming signals.
Payrolls increased by only 22,000 in August, following revisions that showed downward adjustments of 21,000 for July and June. In July alone, payroll growth was a mere 73,000, with earlier estimates for May and June cut by 258,000. Furthermore, preliminary annual adjustments reveal that the economy gained 911,000 fewer jobs in the previous year than initially reported.
Long-term unemployment is also on the rise, with 1.8 million individuals out of work for over 27 weeks—almost a quarter of the total unemployed population.
Simultaneously, the adoption of AI and cuts to costs could further diminish labor demand, while an aging workforce and reduced immigration tighten labor supply. Fed Chair Jerome Powell referred to this as a “curious kind of balance” in the job market.
In other words, the job market seems to have hit a standstill, creating challenges even for recent graduates seeking employment. The unemployment rate for recent graduates—aged 22 to 27—has risen to 5.3%, compared to the overall unemployment rate of 4.3%.
The latest figures from the ADP employment report, which measures private-sector employment, indicate that the economy lost 32,000 jobs in September—representing the largest decline in 2.5 years. This is concerning; however, economists typically await official Bureau of Labor Statistics data to validate the accuracy of such reports.
Due to the shutdown, the government data initially expected on October 3 will not be released, further clouding the understanding of economic conditions.
Limits of Federal Rate Cuts
This uncertainty intensifies the already precarious situation for the U.S. economy, compounded by the fluctuating tariffs and newly imposed duties on goods like lumber and furniture from Trump.
In response to these issues, the Fed is likely to cut interest rates at least twice more this year to stimulate spending among consumers and businesses after its September quarter-point reduction. However, this move raises fears of rekindling inflation, though the cooling labor market is a more immediate concern for the Fed.
While reduced short-term rates may offer some relief, they cannot tackle deeper systemic issues, including massive government deficits, growing debt, strained household budgets, the housing affordability crisis, and a shrinking labor force.
The pressing question is not whether the Fed will cut rates—it’s almost certain—but whether such a cut will genuinely help, particularly if the shutdown persists for weeks. Monetary policy alone is insufficient to address the uncertainties created by tariffs, fiscal irresponsibility, and companies that are replacing labor with technology, compounded by the impacts of the shutdown and consumer anxieties regarding the future.
Lower interest rates might offer a temporary reprieve, but they won’t rectify the structural issues facing the U.S. economy.
