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Such financial market disruptions would very likely be coupled with declines in the price of equities, a loss of consumer and business confidence, and a contraction in access to private credit markets. Financial markets, businesses, and households would become more pessimistic about a quick resolution and increasingly worried that a recession was inevitable.
More and more people would feel economic pain because of delayed payments. Take just a few examples: Social Security beneficiaries seeing delays in their payments could face trouble with obligations such as rent and utilities; federal, state, and local agencies implementing urgent pandemic-related work might see delays in payments that interrupted their work; federal contractors and employees would face uncertainty about how long their payments would be delayed.
Those and other disruptions would have enormous economic and health consequences over time, and ultimately the cuts to federal spending would cause a deep recession. That recession would be particularly painful in the midst of the pandemic. Moreover, tax revenues, the only resource the Treasury would have to pay interest on the debt, would be dampened, and the federal government would have to cut back on non-interest outlays with increasing severity.
In a worst-case scenario, at some point Treasury would be forced to delay a payment of interest or principal on U. Such an outright default on Treasury securities would very likely result in severe disruption to the Treasury securities market with acute spillovers to other financial markets and to the cost and availability of credit to households and businesses.
Those developments could undermine the reputation of the Treasury market as the safest and most liquid in the world. It is obviously difficult to quantify the effects of a binding debt limit on the macroeconomy.
However, history and illustrative scenarios provide some guidance. As discussed in this Hutchins Center Explains post, when Congress waited until the last minute to raise the debt ceiling in , rates rose on Treasury securities scheduled to mature near the projected date the debt limit was projected to bind—by between 21 basis points and 46 basis points, according to an estimate from Federal Reserve economists , and liquidity in the Treasury securities market contracted.
The fact that the estimated effects are small in comparison to the U. In October , the Federal Reserve simulated the effects of a binding debt ceiling that lasted one month—from mid-October to mid-November —during which time Treasury would continue to make all interest payments. The Fed economists estimated that such an impasse would lead to an 80 basis point increase in year Treasury yields, a 30 percent decline in stock prices, a 10 percent drop in the value of the dollar, and a hit to household and business confidence, with these effects waning over a two-year period.
According to their analysis, this deterioration in financial conditions would result in a mild two-quarter recession, leading to an increase in the unemployment rate of 1.
Such an increase in the unemployment rate today would mean the loss of 2 million jobs in and 2. Macroeconomic Advisers conducted a similar exercise in It assessed the economic costs of two scenarios — one in which the impasse lasted just a short time and another in which it persisted for two months.
The Appendix contains further discussion of provisions attached to debt ceiling legislation, including bills in , , , , , and Policymakers should work promptly to raise or suspend the debt ceiling.
Failing to raise the debt ceiling would be disastrous. It would result in severe negative consequences that experts are not capable of predicting in advance. Even threatening a default or taking the country to the brink of default could have serious implications. Importantly, though, failing to control the national debt would also have negative consequences; rising debt could ultimately stunt economic growth, reduce fiscal flexibility, and increase the cost burden on future generations.
Thus, lawmakers should consider accompanying a debt ceiling increase with measures to begin addressing the debt. To be sure, political advantage should not be sought by threatening default, and the debt ceiling must be raised or suspended as soon as possible.
Lawmakers must not jeopardize the full faith and credit of the U. Increasing the debt ceiling requires frequent and often contentious legislative action. While a number of increases have been used to enact fiscal reforms, many increases are not necessarily tied to fiscal health. For instance, debates regarding the debt ceiling often take place after the policies producing the debt have already been put in place. The debt ceiling also measures gross debt, which means that even if the budget was balanced, the debt ceiling would still have to be raised if surpluses accumulated in government trust funds like Social Security.
In The Better Budget Process Initiative: Improving the Debt Limit and subsequent publications , we have suggested reforms to the debt ceiling, grouped in four major categories:. Although the deficit reduction goals under GRH were not fully achieved, the experience gained under the act contributed to the development of more workable and effective procedures five years later.
Like its predecessor, GRH II attached a deficit reduction measure to the increased debt limit, requiring automatic sequester if deficits did not meet annual targets. Additionally, it created enforcement procedures in the Budget Enforcement Act BEA , which helped lead to budget surpluses in the late s.
The BEA also created adjustable limits for separate categories of discretionary spending and the pay-as-you-go PAYGO procedure that required tax cuts or increases in mandatory spending to be offset. Congress approved six temporary increases in the debt limit while negotiations to implement the budget agreement were ongoing. The agreement extended the original spending caps from and raised taxes on high earners, among other reforms.
That, in turn, would also send other borrowing costs higher, including credit cards , car loans and mortgage rates which generally are pegged to yields on U. Treasury notes. Just the fear of default could rattle the stock market and send shock waves throughout the economy, according to Bankrate's Hamrick.
In , a debt limit standoff in Congress brought the country very close to a default before lawmakers finally struck a deal, but not without a downgrade of the country's credit rating and significant market volatility. This time, lenders may start tightening their standards to reduce their exposure — or risk — during a contentious battle in the weeks ahead, said Yiming Ma, an assistant finance professor at Columbia University Business School. In , Congress voted to suspend the debt limit until July 31, Now, the Treasury is using temporary "emergency measures" to buy more time so the government can keep paying its obligations to bondholders, veterans and Social Security recipients.
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