Brian Beaulieu has served as CEO and Chief Economist of ITR Economics™ since 1987, where he researches the use of business cycle analysis and economic forecasting as tools for improving profitability.
Congress and the White House are engaged in high drama over raising the debt ceiling.
How the drama unfolds matters because it could mean:
- The US defaults for the first time in over 200 years.
- Spending cuts might be agreed upon.
- Tax increases may be agreed upon.
- Both sides may agree to move on by suspending the debt ceiling limit until it is budget time or later.
- The government could shut down (likely to make some people happy!)
Congress has managed to increase the debt ceiling on 78 occasions since 1960. The increases occurred 62.8% of the time under a Republican administration. Democrat administrations have presided over 37.2% of the debt ceiling increases. If you have lived long enough, you can easily remember earlier times when we went through this.
The number of times the country has faced the current situation makes it easy to be sanguine about the current circumstance. However, following a global pandemic and never-before-seen fiscal and monetary policy extremes in the US, anything should be considered.
How the Politicians Resolve the Current Dilemma Matters
2011 is a recent instance that may be germane to the current drama. President Obama conceded to some spending cuts demanded by Republicans in Congress. This occurred despite Democrats’ control of both chambers of Congress. Then-Vice President Biden had a ringside seat as the Obama administration broke with precedent and negotiated spending cuts as part of the deal to raise the debt ceiling. The compromise called for up to $2.4 trillion in savings over a decade. The White House claimed that the compromise would cut deficits by $4 trillion over 12 years.
- Federal spending declined for two consecutive fiscal years and then crept up for one year before returning to a normal rate of rise.
- The US national debt continued to rise, albeit at a slower pace.
- National debt as a percentage of GDP stabilized (because the economy was growing) for three years before accelerating higher.
- President Obama’s projected $4 trillion cut over 12 years is assumed to be in context of “$4 trillion less than it otherwise would be,” because the national debt pre-COVID was already up $7.7 trillion dollars (53.8%).
What May Happen if the Debt Ceiling is Raised
The final compromise or decision to kick the can down the road is not known. Using the Republicans’ proposal as a possible result and knowing the CBO estimates that federal spending would be lower by $129 billion in fiscal year 2024 (2.1% of last year’s federal spending and 3.1% of the fiscal year before COVID), we estimate:
- GDP will be modestly negatively impacted, but that means the decline we are already forecasting could be slightly steeper.
- Inflation may come down to a greater extent.
- The national debt will continue to rise.
- Debt as a percentage of GDP will rise further.
- The debt ceiling drama will play out again in fiscal year 2024 given the spending plans already committed to by Congress and the president.
What Happens If the US Defaults
No one knows for sure. Part of the equation is whether we default for one day. One week. One month. The US has not defaulted on its debt since the War of 1812, when the British burned down multiple buildings in Washington, DC, including the Treasury.
Some combination of the following is likely:
- The Fed monetizes the debt (they had a plan to do this in 2011). This could buy the politicians time, but the economy would eventually pay the price for this action in the future.
- Interest rates rise.
- Taxes rates go up and spending is cut.
- The recession of 2023–2024 is steeper than ITR Economics is currently forecasting.
- The recession potentially lasts longer than ITR Economics is forecasting.
- Inflation goes down further than we are currently forecasting because of the recession before going even higher after the recession, if the dollar weakens.
Since the US has faced this situation many times before, there are a few different paths to take to combat the issue at hand. We will continue to keep a close eye on whether the US will raise the debt ceiling in 2023, and keep you informed on the economic implications that follow the decisions.