ECON430-Topic #2: The Debt Ceiling

The debt ceiling has been a contentious point in Congress for several years, and the current government shutdown might bump into the current budget crisis in only a couple of weeks. The debt ceiling has never been breached, and has always been raised before the U.S. defaulted on their debts. While the Republicans are currently threatening to not increase the debt ceiling, in the past Democrats have done the same. So, while this is a political issue, it is also a very important economic issue that relates to monetary policy.

Questions you might answer:

Do not necessarily limit yourself to these topics, and not necessarily these articles. You should read all or most of them and formulate a fact-based opinion that you can use to argue your point. I am not grading you on the correctness of your opinion, only whether or not it is convincing based on the facts you display. (Note: pointing out that pundits like Paul Krugman or Charles Krauthammer agree with you is not a fact.)

12 thoughts on “ECON430-Topic #2: The Debt Ceiling”

  1. The current timeframe that presents a government shutdown with an imposing US Debt Limit decision seems rather dismal for the Global Economy. The Republican and Democratic representatives are currently in a deadlock over the fast-approaching deadline, a scenario similar to the decision of 2011. During the August 2011 stalemate, that barely avoided default, “the blue-chip stocks in the Dow Jones fell 17 percent and the United States lost its top-tier Standard and Poor’s credit rating. The episode cost the Treasury $1.3 billion in higher interest costs that year (Reuters, 2013).” While some analysts view the government shutdown as a “non-event”, the consensus opinion from the top CEOs of US companies concerning the US Debt Limit is not as encouraging. “There is precedent for a government shutdown. There’s no precedent for default. We’re the reserve currency of the world (Goldman Sachs CEO, Blankfein)”. Many forecasters predict that a government default would cause cash funds to deplete rapidly, forcing a freeze on payments, such as Social Security and payments to bondholders who wish to be repaid instead of rolling over the paper. Interest rates would likely skyrocket to offset the risk of holding Treasuries. The following effects, which are hard to predict, could spark a global credit freeze similar to the conditions when Lehman Brothers failed.

  2. With both republicans and democrats unwilling to budge on their current political disagreements despite the government shut down and impending debt ceiling issue, it is evident that congress and the Obama administration are facing their own public version of a market failure. Several parallels can be drawn between unforeseen externality issues historically seen in the private sector and Obamacare. This is apparent based on the fact that this proposal was enacted back in 2010 under the 111th congress in which both the house and senate were a majority democratic (senate.gov). The goal of the president was clearly to provide more affordable healthcare. However, it is highly unlikely that anyone could have predicted that the act would become intertwined with raising the debt ceiling and conducting general policy making. With GOP members like Senator Ted Cruz, speaking for over 20 hours in an effort to stifle the act (Yahoo News), it is clear that Obamacare has bred unforeseen and negative stalls in policymaking, and it cannot be dealt with by imposing legislation like many other private sector externalities due to the fact that the issue at hand lies within the legislative bodies. Without being able to use common methods of dealing with negative externalities, such as taxes and regulations, the only efficient way to remedy the situation is the unlikely case that a compromise is made either in the form of revisions to Obamacare, spending, or taxation.

  3. If Congress fails to raise the debt ceiling, the financial and economic consequences could be severe. In August 2011, Congress faced a similar debt ceiling crisis and narrowly raised the debt ceiling just one day before default (Bloomberg). Rating agency Standard and Poor’s downgraded the U.S. credit rating from AAA to AA+ (Washington Post). Financial markets reacted violently, as the S&P 500 index fell over 16% in two weeks of trading. The VIX, or volatility index (also known as the “fear index,” a measure of implied volatility in S&P 500 index options), reached its highest level since the end of the financial crisis (Yahoo! Finance). This time around, if Congress fails to act, financial markets could react even more violently than in 2011.

    Failure to raise the debt ceiling would trigger a U.S. default on its debt obligations. As Ben Bernanke mentioned in his September 18th news conference, the Federal Reserve has a limited ability to offset economic shocks caused by the debt limit (Reuters). A default would likely cause a drop in the value of U.S. debt securities and thus a rise in interest rates. Lending and economic activity could dry up as a result. A drop in U.S. treasury values could also force money market mutual funds to rapidly sell treasuries and “break the buck,” similar to the failure of Lehman Brothers in 2008 (Yahoo! Finance). Though President Obama has options in case of a default, there would likely still be severe consequences in the short-term should Congress not raise the debt ceiling.

    Sources:
    http://www.bloomberg.com/news/2011-08-01/obama-debt-cap-deal-with-congress-leaders-avoids-default-vote-due-today.html
    http://articles.washingtonpost.com/2011-08-05/business/35417342_1_downgrade-aaa-credit-ratings-government-debt
    http://finance.yahoo.com/blogs/breakout/u-treasury-default-catastrophic-consequences-explained-170230218.html

  4. The debt ceiling has remained an integral aspect of modern politics and government functions. The continuous increase of the US debt ceiling extends our line of credit and allows our government to pay its dues. With our current debt of roughly $16.7 trillion dollars we are on the verge of breaching that ceiling, essentially defaulting on our debts which will lead to the inevitable downgrade of or credit rating. As the world reserve currency, this poses a potential 2nd global financial crisis within a decade from which the first we have not fully recovered. In the past, both political factions have used the unceasing elevation of our debt ceiling as negative propaganda when opposing a political rival; Most recent with then-Sen Obama asserting to former president Bush in 2006 that, “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. government can’t pay its own bills.”(Johnson) Henry Allen, long time tax expert argues that President Obama should ignore the debt ceiling and proceed as usual. Of the options that the president has, that would be least unconstitutional. President Obama should not completely ignore the debt ceiling but devise a plan to reduce the constant noise surrounding it. The contention that the US will not pay its debt is absurd considering part D of the 14th Amendment says as a country we will not default on our debts. Both parties should construct a system in which the ceiling can be maintained at a gradual pace to allow the government the security it needs to pay its bills. This would rescind either parties’ ability to use our credit rating as a bargaining chip and promote global financial stability.

  5. A breach of the debt ceiling and US default would undoubtedly have devastating effects. Default will hurt both the private sector and the government’s ability to borrow at low rates (NY Times – How Debt Ceiling…). The Federal Reserve has worked tirelessly since 2008 to keep rates low in order to provide households, businesses, AND the federal government with easy, cheap access to capital. The ability to borrow at low rates has propped up the economy and an increase in rates could undo all of the progress that the Fed has created sending the US back into recession or even depression (Time – Business and Money). According to the Treasury, the effects from such an event would be felt for more than a generation. (Financial Post).

    Barkley Rosser and many other economists note that the 14th amendment basically prohibits the federal government from defaulting on its debts (Barkley Rosser’s Blog). However if President Obama were to simply ignore the debt ceiling, many further uncertainties would be created. Upon reaching the ceiling without a resolution, markets would not react positively to the message sent by policy-maker’s inability to compromise and the potential impeachment of President Obama for not honoring the debt ceiling (NY Times – Obama Should…). During the debt ceiling negotiations of 2011, the S&P plummeted 16 percent over the course of about 2 weeks in late July into early August (Bloomberg). In this instance, the debt ceiling was raised and crisis was averted. We may not be so lucky this time. Regardless of whether or not the US technically defaults, markets are in for a thrill if policy makers cannot promptly come up with a solution.

    http://www.nytimes.com/2013/10/04/us/politics/how-debt-ceiling-could-do-more-harm-than-the-impasse-in-congress.html

    http://business.time.com/2011/07/11/how-a-u-s-government-default-would-affect-consumers/

    http://business.financialpost.com/2013/10/03/u-s-treasury-warns-debt-default-could-plunge-america-into-worst-recession-since-great-depression/

    http://www.nytimes.com/2013/09/30/opinion/obama-should-ignore-the-debt-ceiling.html

    Bloomberg

  6. The government shutdown has brought things in Washington to a halt and it is looking ever more likely that the partisan standstill is going to run up to the October 17th deadline when The United States will default on its debt. The question of what type of effects a debt default will have for The US is an interesting one. On the one hand, the US was in a similar position in 2011 when politicians were playing chicken with defaulting on the debt. In the end, politicians came to an agreement that raised the debt ceiling before a default occurred, but not without the consequence of Standard and Poor’s downgrading the US to an AA+ credit rating. A decrease in a country’s rating is supposed to signal that it is a riskier investment and so investors should be receiving additional compensation, in the medium of higher interest rates, for allowing governments to use investors’ money. Therefore, in the aftermath of the downgrade, the interest rates on US bonds should have gone up, but empirically this has not been the case. The US continues to borrow at a lower rate than AAA rated countries such as Australia and Canada indicating that there is more than just the credit rating agencies opinion that matters. It seems that foreign investors have a very strong belief in the US’ ability to pay back its obligations at some point or another.

    If the US hits its debt ceiling, it seems as though one of two things will happen: Investors will lose all faith in the US and the cost to borrow will skyrocket or investors will, for the most part, disregard the breach of obligations. After all, it is not as if on October 17th the US will suddenly pay zero obligations. To the contrary, the US is bringing in money and spending money daily. If $100 dollars is paid out a day, and suddenly because we have hit this ceiling we are only allowed to pay out less than that value, it is likely we will pay off China first and park rangers last. This may not be a very pleasant idea for the more patriotic among us, but the fact still stands that our financial obligations are prioritized and we will pay the most important first.

    I think that, like the downgrade, hitting the debt ceiling is not going to be as detrimental as pundits say and most certainly will not be devastating or cause a global credit freeze. Yes, the US may be forced to pay more to borrow. There are consequences to senseless brinkmanship that we bring upon ourselves; however, given the relative risk of other countries around the world, I believe investors’ confidence in the US will hold. People are not ready for the US to be a mal-investment regardless of the true fact. People will continue to believe much as they had before.

    Lastly, an interesting idea I heard that had been batted around was for the Fed to make a repurchase agreement with large banks in the US. In this, they would take the excess reserves banks have on hand in exchange for some sort of short term security that would roll over every 30 days or so (presumably this agreement would allow them to make more than the .25% they currently make sitting on the money). If we do breach the debt ceiling without an agreement, the cash could then be given to the US Treasury to pay off debts. This would come at the expense of the Fed’s independence from the federal government, but perhaps it is time to give our monetary policy makers a turn at the driver’s seat since our fiscal policy makers cannot seem to get the job done.

  7. Looking at historical data alone, it is likely that the debt ceiling will be breached and then eventually raised. It is the least bad decision that Obama can make in this political standstill. Republicans are probably not going to agree with the Democrats to raise the debt ceiling because they are only going to agree if there is a huge revision or even abolishment of Obamacare, which is obviously not in the Democratic game plan (Politico). Since the settlement is so conditional, it is likely that the debt ceiling will be breached. I would be very surprised if Obama chooses to favor the debt ceiling, which is the only one to exist on the planet, over paying lawful bills or making unnecessary tax hikes (Rosser). Certainly this decision will have adverse effects on the economy in regards to a decline in consumer confidence in the short term, but it will be better than blatantly not paying bills or infuriating citizens by taking a portion of their incomes to pay for government failures. The Treasury could try to impose “extraordinary efforts” to compensate for some of the debt again, but they certainly seem to be inferior to government spending habits since there have been consistent suspensions to the debt limit in the past (Congressional Research Service).

    http://www.politico.com/story/2013/10/collision-course-continuing-resolution-debt-ceiling-congress-government-shutdown-97693.html?ml=tb

    http://econospeak.blogspot.com/2013/09/henry-aaron-calls-for-obama-to-ignore.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+espeak+%28EconoSpeak%29

    http://www.fas.org/sgp/crs/misc/RL31967.pdf

  8. Given the 14th Amendment, the United States government will be paid; the idea of national default on its obligations was once fantasy. However, if and when it occurs, Obama will be forced to break the law of the land with one of three possible decisions. Probably the best way for the president to handle this situation is to simply ignore the debt limit. This is an issue in and of itself, because it is currently against the law to borrow money to pay the government’s bills once the ceiling has been reached. However, the ramifications will likely be less severe than his alternative choices. Again, given the 14th Amendment this law could be argued unconstitutional and should be removed from the books. Perhaps the next best option is to unilaterally increase taxes to begin to pay off debt. However, since this measure would be both highly unconstitutional and extremely unpopular there is little doubt Obama would run the risk of being impeached by both houses of Congress despite a Democratic majority in the senate. The last potentially bad option, simply defaulting, is most certainly the worst of the three. Default could result in yet another United States economic recession, as well as, one on a global scale since it has been pointed out that the U.S. dollar is the global reserve currency. However, this would be avoided if Congress and President Obama would cooperate with each other. Unfortunately, redistricting has allowed partisan ideologues to gain control, especially in the House. For example, in the 2012 general election Virginia Republicans won 73% of the seats in the House of Representatives while Obama gained 53% of the overall vote. Partisan redistricting has reduced the need to appeal to those outside of the extremes of their respective parties, thus, incentivizing representatives to use the brinksmanship tactic controlling the current negotiations. As a result, neither Republicans nor Democrats have made any meaningful attempts to bridge the impasse, at which they currently find themselves, so the nightmare of choosing the least catastrophic option will soon become a horrifying reality for President Obama.

  9. This isn’t the first time the United States has approached a debt ceiling. By observing the nation’s credit rating during these times we can propose a prediction of what might happen in the near future. On August 5th 2011 the Standard & Poor’s lowered the national credit rating from AAA to AA+. This was in response to the uncertainty about how to handle the budget and the federal debt ceiling, sounds oddly familiar. Uncertainty is one of the main factors that contributes to the rise and falls in business cycles and the international markets. According to the chart seen in Washington Post article, the market never lived up to what the S&P predicted. Canada and Australia (AAA nations) have to pay a premium to borrow while AA+ rated U.S does not. The United States credit is not a risky as it was originally thought to be.
    S&P backed up their argument for the rating saying “The current impasse over the continuing resolution and the debt ceiling creates an atmosphere of uncertainty that could affect confidence, investing, and hiring in the U.S.” They place the blame largely on politic turmoil and uncertainty. Many large business leaders are worried about the potential outcome if the debt ceiling is not raised. Others disagree on certain political opinions but come to a consensus which the significance of the decisions at hand. The unknown long term affects of the government shutdown are alarming.

    http://finance.yahoo.com/news/ceos-white-house-warn-adverse-effects-shutdown-debt-174112263–sector.html
    http://www.washingtonpost.com/blogs/wonkblog/wp/2013/08/05/sp-screwed-up-when-it-downgraded-u-s-credit-2-years-ago-heres-proof/
    http://www.forbes.com/sites/afontevecchia/2013/09/30/shutdown-and-debt-ceiling-debate-prove-u-s-doesnt-deserve-aaa-credit-rating-sp/

  10. The last time we raised the debt ceiling the U.S rating dropped from AAA to AA. This is really a useless rating overall, until the rest of the world starts to not believe in the United States their will be no problems. Overall the republicans like the democrats of the past are purely bluffing. The debt ceiling will be raised and there should be no reason for fear that the debt ceiling and the national budget crisis. This overall is just a bunch of politicians blowing steam out of their nose with nothing really getting achieved over this whole time and building up more debt.
    The very rare chance the debt ceiling is not moved their is a high chance of total U.S. economic failure. All business would be in crisis mode and peoples confidence would drop. The U.S. government would then run out of money between October 21st and October 30th. In the rare possibility this does occur , it would mean that the U.S. would then have to start paying higher interest on its debt to attract lenders. This would then ripple throughout the U.S. economy causing higher interest rates and fees. Its believe that it could even jump up 1 whole percent at first and then as the crisis gets worse go even higher. This would also reduce consumer confidence and cause people to save instead of spend and borrow thus damaging the economy even more. These are only the things we can assume would happen. This is a realm that the economy hasn’t reached in a long while and will lead to large arguments in the realm of economics that what would be the next step fiscal or monetary and where would the focus have to be put to start to solve the problem . I overall think the government wouldn’t allow the interest rates to raise to such high rates but placing a ceiling on it. This would then delay the problems for the future giving the government more time to try and figure out what the correct steps are to be taken.

    Source: http://www.investopedia.com/financial-edge/0811/how-the-credit-rating-downgrade-affects-the-u.s.-economy.aspx

  11. I’m not worried. I’m broadening my money.
    The approach of the debt ceiling in 2011 is a good case study. That experience has taught the market to discount potential volatility related to policy markets. Fiscal policy makers reached a deal. Incorporating dynamic economic theory i.e. elements of the Lucas Critique; we can see that the market believes policy makers will reach a deal. People are pricing this into the market. There aren’t pronounced spikes in the VIX or drops in equities. Currently, bearish positions are not prevalent relative to tail hedges and volatility dampeners. Short term volatility is a given, and long term stability is assumed. Everyone should be “broadening” their money. Invest. With easy money, low leverage, and high cash balances; corporate activity should be plentiful. It’s a great buying opportunity. The market is down on the basis of sentiment, not fundamentals. Short term volatility may create buying opportunities for US Treasuries [drops in the price of a bond results in a higher yield].

  12. High deficits, such as the deficits the US currently incurs, require the Fed to respond in one of two ways. First, the central bank can finance the debts by purchasing the securities issued by the government or the private sector purchases the same securities and the Fed tries to limit increases in interest rates. Bernanke explains that increasing the debt ceiling will have many adverse effects on the economy at large, an argument supported by many economists. Large federal deficits place pressure on interest rates to rise, making the Federal Reserve’s job increasingly difficult.

    At the same time, the government will have less money to work with if the Fed does not raise the debt ceiling and it is likely that many Americans will not receive the benefits they are entitled to and individual with Treasury securities would not be paid. The result of this would be a sharp increase in the interest rate of not only Treasuries, but also mortgages and other loans. Investment and other spending will decline eventually shifting the economy into another recession. Given the two sides of the argument, I think it is best for the government to temporarily raise the debt ceiling in the short run to avoid default. The government should additionally develop a long term plan in order to determine how they can better manage debt.

Leave a Reply

Your email address will not be published. Required fields are marked *