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September 19, 2013

Economists warn Congress that delaying action on the debt limit is perilous

September 19, 2013

JointEconomicCommitteeBlog

Lawmakers from both chambers of Congress on Wednesday met with prominent economists to weigh the perils the nation faces as it edges closer to a mid-October deadline for raising the $16.7 trillion debt limit.

And if the past is prologue, the stakes are dangerously high, economists told members of the Joint Economic Committee.

“Debt limit brinksmanship is costly, even if Congress avoids breaching the limit at the last minute,” said Donald Marron, the Urban Institute’s director of economic initiatives. “The 2011 showdown scared investors and consumers, slowing the economy, and drove up Treasury borrowing costs.”

Indeed, when Congress sparred over the debt ceiling in the summer of 2011, the Dow Jones Industrial Average fell more than 2,000 points and Standard and Poor’s downgraded the United States credit rating to AA+ from AAA.

The federal government actually reached its debt limit in May and since then the Treasury Department has employed extraordinary measures to stay within the limit.

However, Treasury Secretary Jack Lew says those measures will be exhausted as soon as mid October, leaving the government with roughly $50 billion in cash to pay its debts.

“We have about a month left to take action that will allow the U.S. government to pay our bills,” said Sen. Amy Klobuchar, D-Minn., the vice chair of the committee. “We should learn from our experience in 2011 and not repeat it.”

Her Republican counterpart agreed, but didn’t back down from using the debt ceiling to leverage a discussion about other fiscal reforms.

“Political brinksmanship over raising the debt ceiling is costly to our economy,” said Rep. Kevin Brady, R-Texas, the chairman of the panel. “House Republicans have reasonably and prudently passed a bill to take default off the table and invited the president to sit down together—today—to find a bi-partisan solution that puts Washington on a responsible fiscal path through pro-growth tax reform.

David Malpass, the president of Encima Global and a former Republican candidate for a New York Senate seat, agreed saying spending and debt levels need to be lowered now to prepare for future obligations.

“The debt limit provides a good opportunity to address this crisis,” he said.

Moody’s Analytics Chief Economist Mark Zandi, however, told the panel that failing to raise the debt ceiling on time would be like “opening economic Pandora’s box.”

“It would be devastating to the economy,” when it is on the verge of very strong growth, he added.

If the government fails to raise the debt limit before the Treasury Department runs out of options, the government would, in effect, have to immediately balance its budget by cutting spending, said Marron, a former acting-director of the Congressional Budget Office. And if the government had to operate on an imposed balanced budget for a prolonged period of time, the country risks falling into a deep recession, he added.

Making matters worse is the risk that the Treasury Department might also miss interest or principal payments on debt, which would significantly boost the government’s borrowing costs, and threaten financial systems that count on credit-worthy Treasuries to smoothly operate.

In such a scenario, Marron said, markets would begin to unravel as credit tightens, financial institutions rush to gather cash, investors demand premiums for holding Treasury securities and flee from money market funds, consumer confidence falls, and foreign countries lose faith in the United States ability to govern itself.

“Anyone who remembers the financial crisis of five years ago should shudder at the thought of disrupting these markets again,” he said.

Photo of Donald Marron testifying by Matt Johnson, Urban Institute

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