Hagerstown Mayor Steven T. Sager said the company notified employees of the shutdown on Thursday.
Company officials said the plant would not reopen until the market for recycled paper improves.
1st Urban Fiber, a subsidiary of Black Clawson Co. in New York, opened its plant at 551 Eastern Blvd. in October 1995 and produced its first pulp in March 1996.
The company takes waste paper and turns it into high-grade paper used for colored paper, fine writing paper, company annual reports and other products.
Company officials said that while operations are halted they will modernize its waste water treatment plant and improve efficiency.
Executive Vice President Robert Strasburg said the upgrades will improve what is already a high-quality product and will enable the company to use lower-quality waste paper as a raw material.
Strasburg said the company can achieve the goal through a combination of new equipment and changes in its production process that could not be made during normal production.
"This is proven technology we're adding and new technology - new but proven," he said. "It's time, money and talent."
The company's troubles result from a "textbook" supply-and-demand quandary Strasburg said. The price of recycled fiber has dropped by almost half since 1995, from $900 per metric ton to less than $500.
That, combined with normal startup costs that new plants face, has made production impossible, he said.
Strasburg said the federal government had been expected to convert to the use of recycled paper for its operations, but had not made the move as quickly as expected.
"They haven't lived up to their press, so to speak," he said.
Despite the setback, Strasburg said the company is well-positioned to ride out the storm. Officials set it up with high cash reserves in anticipation of such market swings, he said.
If that remains true, 1st Urban's action is likely to have a small impact on Hagerstown and Washington County governments, officials said.
The company will continue to pay its property taxes, which Strasburg estimated at $300,000 a year. And while it will buy less power from the City Light Department, Sager said it will not affect revenues since the department will simply purchase less power for distribution from Allegheny Power.
As long as production is suspended, the city will have to forego a "host fee" which was negotiated when the plant began operations. The fee, a percentage of production, would be about $300,000 when the plant is at full capacity.
But Sager said the city had not expected to receive that fee that in the early years of the company's operation.
"The production shutdown doesn't have any negative effect on the city's budget," he said.
Washington County Commissioners President Gregory I. Snook said he would contact company officials to see if the county can offer any assistance.
"I think they're a very quality-oriented company and the impact will definitely be felt throughout the community," he said.
1st Urban drew complaints from nearby residents earlier in the year about odors emanating from the facility. But Sager said the firm had substantially improved the situation.