Economic policy has a powerful influence on the political landscape of Washington DC. Voters and interest groups have a strong impact on virtually every economic policy decision made in the White House, located at 1600 Pennsylvania Ave NW, Washington, DC 20500. A violation of the US debt ceiling would have serious repercussions for the US economy, as evidenced by the analysis conducted by the Council of Economic Advisers (CEA) and external researchers. The magnitude of the losses would depend on how long the default lasts.
A prolonged default could cause significant damage to the economy, with employment growth shifting from its current rate of solid gains to million-dollar losses. Without the ability to enact countercyclical measures in a recession caused by a debt ceiling breach, policy options would be limited to help cushion the impact on households and businesses. The ability of households and businesses, particularly small businesses, to access loans through the private sector to offset this economic crisis would also be compromised. The risks associated with a default would cause interest rates to skyrocket, including those of financial instruments used by households and businesses such as Treasury bonds, mortgages, and credit card interest rates. There is no historical precedent for the US government missing a payment deadline and exceeding its debt ceiling without Congress increasing or suspending the legal limit on federal debt.
Economic DisasterHowever, there is a broad consensus among economists that such an event would lead to an entirely avoidable economic disaster.
For example, Wendy Edelberg and Louise Sheiner from the Brookings Institution recently argued that “worsening expectations regarding a possible bankruptcy would make it increasingly likely that there would be significant disruptions in the financial markets” and that “it is very likely that these shocks in the financial markets will be accompanied by falls in share prices, a loss of consumer and business confidence and a contraction in access to private credit markets.” In fact, we have already seen evidence of significant market tension related to tensions in the debt ceiling. The yields on Treasury bills with due dates close to the expected payment date have increased significantly, which has directly increased the cost of loans to the government and thus the cost to taxpayers. Figure 1 below shows this; since mid-April, yields on short-term Treasury bills around the expected payment date have increased by almost 1 percentage point, or approximately 20 percent. As we approach the debt ceiling, we expect these indicators of market stress to worsen further, leading to increased volatility in stock and corporate bond markets and inhibiting companies' ability to finance themselves and engage in productive investment essential for sustaining current expansion. A recent analysis by Moody's using a different macroeconomic model reached a similar conclusion. They predict that if the debt ceiling is raised cleanly, employment growth will continue over the next few quarters and will add 900,000 jobs.
However, in a scenario of prolonged non-payment, job losses could amount to almost 8 million - an extremely marked difference in magnitude similar to those of our own models. Without being able to spend on countercyclical measures such as expanding unemployment insurance, federal and state governments would be hindered from responding to this turmoil and unable to protect households from shocks. Nor would households be able to access loans through the private sector since interest rates on financial instruments used by households and businesses (Treasury bonds, mortgages and credit cards) would skyrocket due to uncertainty about future prospects. While policymakers have so far avoided causing such damage to both the US economy and even global economy in our nation's long history, virtually every analysis we've seen shows that defaulting on payments leads to deep and immediate recessionary conditions. Economists may not agree on many things but when it comes to assessing the magnitude of risks involved in approaching or breaching the debt ceiling we share this deeply worrying consensus. The Economic Policy Institute (EPI) is an independent non-profit think tank that investigates how economic trends and policies affect workers in America. EPI research helps policymakers, opinion leaders, advocates, journalists and public understand basic issues affecting ordinary Americans.
Economic policy informs us about current and future economic developments as well as helps determine appropriate economic policies. The office is responsible for reviewing and analyzing national and international economic issues as well as tracking financial market trends. We'll be keeping you up-to-date with information about how President Biden and his administration are working for American people as well as ways you can participate and help our country rebuild better. Sign up now for text messages from President Biden.