While President Joe Biden says that he is confident he can reach a deal with Republicans over the debt ceiling, Treasury Secretary Janet Yellen is warning of “economic chaos” should that not come to fruition.

Virginia Tech economist Jadrian Wooten says if a deal is not reached by June 1, the impact on the U.S. and globally would be significant. “We’re potentially facing significant declines in Gross Domestic Product and the potential for millions to be out of work. The long-term issue is a reduction in investor confidence in government securities,” says Wooten. 

Wooten explains that a reduction in investor confidence would raise the cost of borrowing for the U.S., which trickles down through the banking system. “Higher borrowing costs resulting from a default or increased risk perception could further increase interest rates, making it more expensive for businesses and individuals to borrow and invest. This can dampen investment, hamper economic growth, and potentially lead to job losses.”  

There are a number of obligations that the U.S. government wouldn’t be able to fully pay, like Social Security, Medicare, SNAP recipients, and interest on federal debt. “By refusing to raise the debt ceiling, we’re essentially refusing to pay what we owe people,” says Wooten.  

In addition, Wooten explains the U.S. dollar is the world’s primary reserve currency and any disruption in its stability and credibility could have far-reaching consequences. “Investors worldwide hold U.S. Treasury bonds as safe assets, and a default or downgrade of U.S. debt could lead to a loss of confidence in global financial markets.”  

Wooten says the U.S. is able to borrow cheaply because the U.S. dollar is in such high demand around the world, but breaking that confidence could trigger international investors to seek other currencies. This in turn would raise the cost of borrowing for the U.S., making a recovery more difficult.  

“It’s essential to balance the need for responsible budgeting with the requirement to meet the government's financial obligations and ensure stability in the economy,” says Wooten. “If politicians are seriously concerned about our debt limits, those need to be addressed before the US commits to paying these obligations and not after the bill has come.”

When it comes to current impact, Virginia Tech economist David Bieri says its the economic and political uncertainty that it is creating at a moment when investors, businesses and consumers already struggle with difficult economic conditions. "One of the key reasons for justifying a strong presence of government during turbulent times is that government policy helps to stabilize economic conditions," says Bieri. "This is what the Fed did during the Global Financial Crisis and most recently in its fight against inflation. And this is what the governments did in their efforts to mitigate the impacts of the global pandemic. Yet, most paradoxically, at this current juncture, the U.S. government is the very source of instability which makes this a historically unique situation."

Since it first came into effect as a consequence of the growing complexity of the U.S.’ borrowing needs to finance World War One, the debt limit has been raised close to a 100 times. "Every time it was possible to find a political compromise essentially to deal with the structural problems of the US budget. This time should be no different, but the structural imbalances of the US government spending are perhaps at their most complex ever," say Bieri.

Bieri explains that in many ways, the current debate over the debt limit is the last act in a slow burning budgetary crisis that the US has been experiencing over the last 40 years. "Even a temporary solution in a one-off raising of the debt ceiling will only provide very temporary reprieve."

About Wooten

Jadrian Wooten is collegiate associate professor at Virginia Tech within the Department of Economics and is the author of Parks and Recreation and Economics. Read more about Wooten’s economic perspective on the debt ceiling debate for subscribers in his Monday Morning Economist newsletter.

About Bieri

David Bieri is an associate professor of urban affairs in the School of Public and International Affairs and an associate professor of economics. He also holds an appointment in the Global Forum on Urban and Regional Resilience. His teaching interests are at the intersection of public finance, monetary theory, and history of economic thought. He has held various senior positions at the Bank for International Settlements in Basel, Switzerland. Prior to his work in central banking, he worked in investment banking in London and Zurich. View Bieri’s full bio.

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