Uncertainty about the debt ceiling will wreak economic havoc even without a default

Republicans in the House plan to hold federal coffers hostage to push through massive cuts to Social Security, Medicare, Medicaid and other programs. This irresponsible recklessness in allowing the federal government to foot the bills that have already accrued to Congress, including previous Republican-controlled ones, will create massive uncertainty. Businesses and households will rein in spending while securing funding for future projects will become more difficult as the fiscal outlook for the coming months becomes gloomier. This will slow down an already flagging economy. Republicans don’t need to default the US government to wreak havoc on the economy. Their threat of default and/or unspecified government spending cuts alone will do significant damage.

The US government hit the debt limit on January 19, 2023. This is an artificial limit, almost unique in the world – only Denmark has one – on how much the government can borrow without Congress agreeing to increase this limit. Treasury Secretary Janet Yellen said her agency would take a number of extraordinary measures to help pay bills well into the summer. At the same time, House Republicans, new to the majority, have said they will not approve an increase unless they can secure significant but unspecified cuts to key programs like Social Security and Medicare. To be clear, this debt has accumulated over decades. This includes, for example, trillions of dollars the administration borrowed during the administrations of Presidents Reagan, George W. Bush and Trump to fund ineffective and regressive tax cuts. But if Congress agrees to upgrade the US government’s credit rating by the time the Treasury Department has no more extraordinary action, the US will default on its debt. The clock is ticking for high stakes and a totally unnecessary fiscal standoff.

This creates massive economic policy uncertainty in at least two directions. First, there’s the question, “Will they or won’t they?” — actual default on the US national debt, that is. To put it mildly, a default would create a whirlwind of economic troubles not just in the US but around the world. Stock markets would collapse, the value of the dollar would plummet, inflation would rise, and the economy would enter a recession similar to the Great Recession. Even a short-term outage would result in a government shutdown as the government would no longer be able to pay for services. When the government shut down during the Trump administration, it cost workers, families, businesses and the economy a heavy price, with an estimated cost of 0.13 percentage points less growth for each week of closure. Second, even without the nightmare scenario of a full-fledged default, people and businesses are wondering what Republicans actually intend to cut, when, and by how much. They’ve said they want to cut Social Security and Medicare. However, the specific cuts and their timing are unclear. It’s also not clear if Republicans will stop cutting back on these much-needed programs in an aging society, or if they will turn to other spending, both defense and non-defense. After all, this is the party that steadfastly refused to spell out its political priorities until voters went to the polls last fall, leaving everyone wondering what they actually want and will do.

This massive uncertainty will contribute to slower growth ahead of the country’s final deadline for a possible US government default in the summer. People prefer not to spend their money when faced with an onslaught of the unknown, including a growing likelihood of layoffs. Households will limit their spending on consumer goods such as clothing and food, but also on services such as housing, utilities, furniture and household appliances. Spending on consumer goods has already declined slightly for much of 2022. New home sales also fell 29.7 percent in the third quarter of 2022, compared with their recent peak in the first quarter of last year, before the Federal Reserve began raising interest in prices. Irresponsible Republican economic policies will only accelerate this downturn, leading to a slowdown in the economy with accompanying layoffs in manufacturing, construction and other industries.

Likewise, companies abhor uncertainty when it comes to using their money for longer-term investments. The uncertainty induced by the Republicans about the country’s solvency is therefore likely to reduce investments. Business investment is recovering from its lows during the pandemic but is still below pre-pandemic levels relative to the size of the economy. In particular, spending on structures such as offices, manufacturing facilities, and mines continues to decline, while spending on equipment such as computers and trucks is barely above 2019 levels. Only spending on software and other intellectual property like patents has increased. That means spending on things that companies can give up fairly quickly has recovered, while things that require longer-term commitments from companies have not. The financial crisis artificially created by House Republicans will only perpetuate this trend, which in turn will lead to delayed job growth in manufacturing and construction.

Uncertainty about Republican plans to let the US pay off its debt is also causing stock market volatility and potential downward pressure on the value of the dollar. In the face of these massive political risks, investors are reassessing their prospects for economic growth, leading to strong ups and downs in stock markets. This was already happening when Standard & Poor’s downgraded the vaunted credit rating on US Treasuries in 2011 amid another fiscal standoff over the debt ceiling. They will also start moving money to overseas capital markets where the debt pause does not apply directly. In doing so, the value of the dollar will continue to fall as people sell dollars to invest abroad as the US government is viewed as a riskier financial bet. The dollar has already lost 5.8 percent of its inflation-adjusted value against the currencies of other advanced economies from October to December 2022. Also, investors will want to be compensated for these greater risks by the US government with higher interest rates – a process that is already taking place. These market movements will make it more difficult for companies to obtain financing at reasonable interest rates as they increasingly compete for money in international markets and pay the increased risks in the US economy with higher interest rates.

The US economy is already facing headwinds from higher interest rates and the fallout from ongoing supply chain shortages. The Republican’s financial frivolity only endangers the economic recovery and thus also the financial security of the people. The US has historically recovered quickly from the depths of the pandemic. Even with very low unemployment rates, many people struggle to make ends meet. Economic growth and a sustained strong labor market recovery must continue to help people get ahead financially. But the new Republican majority in the House of Representatives is creating its own political talking points about the economy and people’s livelihoods, creating massive economic risks for no good reason.

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