The government shutdown could cause a disaster for the US economy if Trump follows through on his threat to continue the fight for 'months'

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  • Most economists agree that the government shutdown will weigh on US economic growth.
  • But according to one economist, if President Donald Trump follows through on his threat to keep the government closed for "months," the hit could be severe.
  • Pantheon Macroeconomics' Ian Shepherdson says if the shutdown lasts through March, then first quarter US GDP could be negative.
  • While the prediction is a worst-case scenario, it highlights the dangers of a long-term shutdown.

While the now record-breaking government shutdown is causing serious upheaval on Capitol Hill, economists say that the closure of large portions of the government is already weighing on the US economy.

But it could get even worse. According to one economist, if the shutdown lasts for "months" - as President Donald Trump threatened in a meeting with Democrats - the US economy could actually shrink in the first quarter of the year.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, laid out a worst-case scenario based on the partial closure of the government lasting through the end of March.

While most economists predict that the shutdown will shave a bit off first quarter GDP due to lost wages to the 800,000 federal employees going without pay, Shepherdson pointed out the compounding effect on federal contractors and businesses that rely on the spending from federal employees.

"We have no way of estimating the impact on government contractors, or the second round effects when those businesses fail, or have to delay paying their employees, subcontractors, suppliers, and creditors, but it will not be trivial," Shepherdson said in a note to clients. "Accordingly, if the shutdown were to last through the whole quarter, we would look for an outright decline in first quarter GDP."

Read more: From airport lines to food inspections, here are all the ways the government shutdown is impacting the lives of average Americans»

A negative GDP print for the first quarter would be a monumental fall and drastic surprise given that most economists expect a reading between 2.5% and 3.0%. But as Shepherdson argued, there is only so much slack that can be given to businesses and consumers hit by the shutdown.

"But firms and farms which go bust as a result of the shutdown can't be magically resurrected when it's over," the economists wrote. "Not every business owner will have lenders as accommodating as those which bailed out President Trump's failing enterprises."

Most research shows that for every week of a shutdown, 0.05 to 0.1 percentage points are taken off of that quarter's growth, meaning the shutdown has chopped off as much between 0.1 to 0.2 points from the first quarter. Given that research, JPMorgan economist Daniel Silver also lowered projections for first quarter GDP growth to 2% from 2.25%.

Silver also said the pain could pick up if Congress and Trump aren't able to come to an agreement soon.

"Thus far it is hard to convincingly detect a macro effect on private sector activity, though risks of spillover to the private sector increase the longer the shutdown lasts," Silver said.

Bank of America economists Joseph Song, Michelle Meyer, and Anna Zhou also reduced their outlook for growth in the first quarter due to the shutdown, but worried that additional downside could occur if uncertainty about government dysfunction starts to leak into consumer sentiment and American expectations.

"Additional drag could be felt if the shutdown generates uncertainty shocks in the economy leading to a decline in business and consumer sentiment and/or a decline in US equity markets," the BAML team wrote. "So far, the indirect impacts have been limited, but they will be become a greater drag on growth as the shutdown continues."

So in the event of a prolonged shutdown, the pain first hits federal employees and businesses that rely on a government program. Then the pain is spread to businesses, landlords, and employees of companies that rely on the people missing out on the government payments.

As that pain builds, Americans and businesses throughout the country get nervous about the dysfunction and missing money, ultimately producing a broader drag on the economy.

While Shepherdson's prediction is a worst-case scenario and such a terrible GDP number would also be an unprecedented economic bite from a government shutdown, the length of the shutdown is also unprecedented and as the economist said, the pain is already starting to build.

"Still, even if the shutdown is over by the end of the month, the hit to growth will be material, and it will hurt first quarter earnings, to say nothing of the costs and misery imposed on government employees, contractors and their families," Shepherdson concluded.
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