Goldman: debt ceiling debacle already hurting economy

We’ve all heard of the bad things that await should the debt ceiling not be raised or if the US’s sovereign rating is downgraded.

But any impact of the Washington quarrel on the US economy now is harder to spot. A note out Tuesday from Goldman Sachs, however, argues that the prolonged negotiations are having a detectable influence on the US consumer.

… the impasse in Washington may already be having an impact on consumer behavior. A sharp drop in measures of consumer confidence in recent weeks coincides with a surge in news coverage on the debt ceiling, and details of two confidence indicators also are consistent with this interpretation.

Goldman adds that consumer confidence is more of a coincident than a leading indicator, so if a deal is reached, it should rebound.

For the time being though, the impasse’s affect can be seen in the following areas, according to Goldman.

1. Consumer confidence has deteriorated more rapidly in recent weeks than economic variables would suggest. The sharp drop in the Reuters/University of Michigan (henceforth “Michigan”) index of consumer confidence from 71.5 in June to 63.8 in the preliminary July reading was much worse than consensus expectations or our own. A model incorporating lags of the unemployment rate, the year-over-year change in the unemployment rate, real average hourly earnings, the S&P 500 index, home prices, and consumer lending standards as proxied by the Fed’s Senior Loan Officer Survey explains only about half of the recent drop. (Both the Michigan and Conference Board measures of consumer confidence also posted poorer readings than economic data alone would have suggested in late 1995 and early 1996, during the later stages of the debate over that year’s budget and the subsequent government shutdown.)

This is perhaps not too surprising given the extensive media attention lavished on the debt ceiling talks (see point two, below). And it’s an interesting contrast to opinion polls that suggest the consequences of not increasing the debt limit are ill understood.

2. The timing of the drop in confidence is consistent with an explosion of media coverage of the debt ceiling impasse. News coverage of the debt ceiling, and the negotiations surrounding an extension, surged in mid-June (see exhibit below). The daily Rasmussen Consumer Index plunged from early June through mid-July; though the initial drop immediately followed the poor May employment report, subsequent declines picked up speed in late June, around the time the talks between Vice President Joe Biden and House Majority Leader Eric Cantor (R-VA) got under way and Senate Minority Leader McConnell (R-KY) raised the possibility that a “Plan B” might be necessary if the issue couldn’t be resolved.

Of course, the drop is also coincident with other bad news: the continuing eurozone whatchamacallit, a rising unemployment rate and the jailing of Ja Rule. And it could reflect a longer lasting drop in consumer confidence. But it does seem that there is a debt ceiling portion (of unknown size) to the jitters:

3. Details of the Michigan confidence report also imply the debt ceiling debate has played a role. The biggest drop in the major subcomponents of the Michigan survey was for the economic outlook over the next year, rather than current conditions or the outlook over five years. This is the time horizon most consistent with the potential impact of a deadlock over the debt ceiling. Furthermore, commentary accompanying the report suggested that consumer “confidence in government economic policies” fell to a new low under the current administration and near a half-century low.

Goldman adds that this fall in confidence will feed through to reduced retail sales, lower expected incomes and, via lower equity prices, wealth effects. Assuming some sort of agreement by early August, this should all prove transient, says Goldman, but the longer the debacle goes on, the more likely that the blip takes on a sense of permanence.

The US’s bifurcated consumer really doesn’t need another hit.

Related links:
Consumption conundrums continued – FT Alphaville
How ‘Gang of Six’ Revived Idea of Grand Debt Deal – The Caucus
US economic cavalry is saddle sore – Gavyn Davies

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