Leading experts weigh in on current policy issues and challenges

Experts weigh in: The debt ceiling.

Washington’s latest fiscal confrontation has already caused a partial shutdown of the federal government and threatens a breach of the federal debt limit. What are the economic, political, and fiscal consequences of hitting the debt limit?

This debate originally appeared on Branch on October 11, 2013. 

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Welcome everyone, and thanks for participating in our Branch discussion. Let's get started with a prediction: What do people think will happen on October 17?


I'm confident that the sun will rise in the east and that Treasury will make all its payments on October 17. Beyond that it gets a bit hazy. Treasury will have around $30 billion in the bank that day, according to Jack Lew's latest letter. The Bipartisan Policy Center and CBO project that money will be exhausted sometime between Oct 22 and Nov 1. So we will be getting perilously close to learning what would happen if Treasury really reaches the debt limit. Let's hope we don't find out.

I think that Congress will have raised the debt limit by then. But if they don't, I think we will start to see some market reactions, though those are really hard to predict. I agree with Donald that we aren't going to immediately default on the debt, but I do think we are likely to begin defaulting on some obligations relatively quickly. And contrary to some popular talking points, the idea that Treasury can prioritize some payments over others is simply not feasible. Nor is it politically sustainable. The bottom line is that going much past the 17th without an increase would throw the country into a serious economic and political crisis.

Here's the key sentence from the Lew letter (emphasis added): "There are no other legal AND PRUDENT options to extend the nation’s borrowing authority." The letter does not say that he runs out of legal options on the 17th, but that he runs out of options that are both legal and prudent. That implies that there are, or may be, additional options to go beyond the 17th that are legal but that the Secretary (or his GC) may deem to be imprudent. 

And when you have to choose between imprudence and risking severe damage, you choose imprudence. 

He can go into November if he has to without prioritizing cash flows. 

October 17th is a soft (which is a nice way of saying false) deadline. But that doesn't mean it's good for Congress to go beyond it.

I'm usually not a cheerleader for government competence, but I have 99 pct confidence that there are plenty of bright people at Treasury who can figure out how to avoid default, presumably by prioritizing payments. The only wild card is whether the White House wants default for political reasons, but I can't imagine that happening. danieljmitchell.wordpress.com

There is no way that a Secretary of the Treasury of the President would go into a full default on the debt. No way. I'm sure the lawyers are working full time on this (even if they supposedly are shut down).

Default on the debt is not the only economic consequence of failing to raise the debt ceiling (by the way, I am not nearly as sanguine as many of you that Treasury will be able to avoid a default on the debt if the breach goes on very long). There will also be a massive, immediate fiscal contraction. In October of 2012, the difference between outlays and revenues totaled about 9% of GDP. A contraction of that magnitude would certainly trigger another recession, even if you believe there are no knock-on effects, which there certainly would be.

What will happen on October 17? My guess is that Tea Party members will still be opposed to the ideas that the government should be open, that the government should pay the debts that Congress authorized it to create, that children who get cancer treatment should actually get that treatment. The only question is whether the rest of the Republican party continues to go along with the Tea Party nonsense or comes to its senses.

There seems to be near-unanimous agreement that Treasury will not default. With that in mind, I guess it's not too surprising that the debate has shifted. Michael Linden argues that failure to raise the debt limit would be bad for the economy. I agree that there might be a short-term impact because resources don't instantaneously get reallocated to more productive uses when the burden of government spending is reduced, but I disagree with his underlying Keynesian argument. William Gale attacks "Tea Party members," but why are their efforts to influence policy as part of the debt limit illegitimate, particularly when compared to Obama's grandstanding back in 2006?

Dan seems to have misunderstood my post. It is not about the "legitimacy" of Tea Party efforts. It is an answer to Howard's question about what will happen on October 17. My answer is that it depends on alot on how the non-Tea-Party wind of the Republican party responds to events between now and then. I am not questioning the legitimacy of the party or their efforts. I am not even sure what legitimacy would mean in this context (ie, it is not a birther controversy). I disagree with the Tea Party's views and strategies, but that's different from saying, which I did not, that their views and strategies are somehow "illegitimate."

Regardless of the exact date, it does seem certain that absent congressional action, we will breach the debt limit sometime in the next few weeks. What happens next? Legal experts disagree about whether the president can prioritize payments after a breach. My question for the economists here is, what are the economic consequences if the president delays default with steps that would be, at best, legally uncertain?

Howard, the Administration delayed the employer mandate and exempted Capitol Hill from Obamacare, in both cases in spite of what the law says. With that track record, it's inconceivable that the White House will allow a default simply because the law on prioritization is unclear. Unless, of course, the President wants default for political reasons. But I don't know of any rational person who thinks that is a real possibility.

Dan: I was asking a somewhat different question. Let's assume, for the sake of discussion, that the president finds a way to avoid default. Whatever he does will be controversial at best. How do you--and others--think the economy will respond to that uncertainty? Will bond buyers demand premiums for Treasury paper that is legally uncertain? What happens to commercial debt? What would be the economic effects if the president suspends government payments to others?

To Dan: I dont see why the President should have to negotiate to keep the government open or to have the government pay the bills **that Congress already authorized the administration to spend.** This kind of sums up that view: twitter.com

To Howard: as far as I know, no one is quite sure of the financial market effects, since this kind of default hasn't ever happened (notwithstanding the small, technical, inadvertent default in 1979 that no one interpreted as a stance about government policy). Two things seem clear: the effects will not be good, and the effects are totally avoidable. I would like to hear more from financial market people on this, as it is not clear to me how default would work its way through financial markets (e.g, if, say, pension funds couldn't hold the bonds any longer or something like that). The macro effects of cutting spending would be like the effects of any other macro spending cut.
would guess.

Bill, the House has passed bills to keep the entire government open. They've approved bills to open up parts of the government. So if you're unhappy that bills aren't being paid, you should probably chat with Sen. Reid or the folks at the White House. Unless, of course, you think it is reasonable for one side to be completely dogmatic and inflexible.

To use the economist's favorite phrase, it depends. Specifically, it depends on how exactly the administration manages things once the cash runs low. Like others, I expect that Treasury will do its level best to not miss debt payments, but there's heightened risk of a mistake once Treasury loses all margin for error. We will thus see more stress in financial markets. We already see some initial indicators of stress: Treasury yields are inverted at short maturities and the VIX is up. In English: investors are demanding a small premium for holding Treasuries that come due around Halloween, and stock market investors see more risk. These effects aren't that big yet (e.g., the VIX is well below the levels of 2011), but would rise.

Howard, I'm very confident that the adults at Treasury, CEA, OMB, etc, will make sure there is no default, but that doesn't mean I'm capable of making accurate predictions about how financial markets will react as this fight progresses. Particularly if the President continues to make borderline-reckless comments that seem designed to destabilize markets for political gain. Or what happens if the Fed Chair and/or Treas Sec also throw some fuel on the fire, as we saw back in 2011 (danieljmitchell.wordpress.com) In other words, there shouldn't be any turmoil in financial markets or the broader economy, but some people in Washington could cause some needless chaos.

Wonky point: The fine folks at the Bipartisan Policy Center have just analyzed the arcane issue of extending the Debt Issuance Suspension Period for certain employee retirement funds. They conclude it's a dubious option of questionable legality; if used aggressively, it would buy a few weeks of relief on the debt limit. bipartisanpolicy.org 

Going back to Keith's earlier point, this option may be one reason why Jack Lew's letter includes the phrase "and prudent".

I think the fact that we are even discussing what might happen if Congress doesn't raise the debt limit is a very serious indication of just how far the extremist members of Congress have pushed us. Dan maintains that nothing bad will happen, but he is very much in the minority. The simple fact is that this is not something we should be playing with at all. There are legitimate and serious disagreements between the parties on fiscal and economic policies, but this is not the right way to hash those out. Elections are. We should not underestimate the long-term consequences of allowing this kind of brinksmanship to become the new normal.

Hi folks - New question for you: Should we replace the debt limit and, if so, with what? 

I think the debt limit is a flawed policy because of the brinksmanship it inspires and its arbitrary timing. A better policy would ensure that Congress consider the debt implications of policy choices when they are made. And ensure that Congress periodically revisit mandatory spending and revenue policies that don't necessarily get evaluated during the annual budget process. But I don't know the best way to do that.

I am with you on the debt ceiling. I can't think of any way to require periodic review of mandatory spending and revenues that did not also build in some bias that would affect the process of review.

With a budget where most spending is discretionary, most of these problems go away. Stalemates eventually lead to balance and then surpluses. Absent that historical way of handling stalemates, one can use triggers that constrain programs when they grow faster than some designated rate or fail to reach some trust fund or other balance. Trying to control a residual, the debt, involves an ex post effort to control ex ante actions.

Gene, have you looked at the "Swiss Debt Brake"? It's basically a spending cap, so it avoids all the problems associated with trying to control a residual. And it should be somewhat appealing to Keynesians since it allows spending growth during a downturn. danieljmitchell.wordpress.com

A new question for everyone: Do people think a six-week debt limit extension could jump-start serious budget talks? If so, what could be accomplished?

Late to the party, but a few thoughts anyway: 1) Historically, debt limit debates have often provided a useful opening for budget dialogue; 2) But those debates were marked by footdragging, not serious threats to refuse an increase; if the Tea Party is bluffing, they're doing a good job of it; 3) Short extensions seem more likely to institutionalize stalemate that resolve it; 4) Real progress is unlikely if Republicans return Obamacare to their short list; 5) Doug Holtz-Eakin has outlined a plausible "soft-landing" huff.to although I'm not optimistic; 6) 

Historians are supposed to debunk political nostalgia, not indulge in it, but I really do think we've reached a new low in our national capacity for bipartisan dialogue.

With tongue partly in cheek, I will note that a six-week extension would (if I have my calendar right) align the debt limit debate with the start of Thanksgiving recess, when members really want to go home. 

Let me add another question: What do folks make of the idea (reportedly part of the Republican proposal) to eliminate permanently many of the extraordinary measures? My first reaction is positive. The measures are so well-used that they are effectively ordinary, not extraordinary. And several are gimmicks that look remarkably like raids on employee pension funds. So maybe we could reduce gimmickry while having no effect on the debt limit strategy and outcomes? Or would we still lose useful flexibility (e.g., doing a questionable DISP)?

Responding to Howard's question, my GOP friends on the Hill say there is no coordinated strategy. Some Members view the short-run debt limit as a way of clearing the deck so they can concentrate on the CR/Obamacare fight. Others see it is a way of enabling a "grand bargain" discussion. Others don't want any fight and would prefer to throw in the towel. All that being said, my guess is that the shutdown will last longer under a six-week debt limit extension.

All good questions and comments. I am intrigued by the idea of taking away the extraordinary measures, especially if doing so would remove one layer of confusion and mistrust, namely identifying the date when the government really, truly hit the debt ceiling in a real sense.

Again with an historical note, complaints about avoidance measures have been a fixture of debt limit debate for a long time. Eisenhower used all sorts of gimmicks to stay under the ceiling when Congress denied him an increase in 1953 -- including sales of gold from Fort Knox. And Johnson was excoriated by Republicans for issuing participation certificates that technically (or at least arguably) weren't subject to the limit. GOP tried repeatedly to eliminate or at least limit such measures -- without much success.

Over on TaxVox, I took a crack at summarizing the pros and cons of eliminating the extraordinary measures: taxvox.taxpolicycenter.org 

Timing turns out to be an important issue. With extraordinary measures, it is difficult for Congress to target exactly when the debt limit will be hit. Without extraordinary measures, it's easy. Congress can specify that the debt limit gets hit on November 22, and that's what would happen. I suspect people differ on whether that's a feature or bug.

Thanks very much to you all for your insights and a fascinating discussion. We invite you and all others to continue it in the comments of our blog post featuring this conversation. blog.metrotrends.org