The US Debt Ceiling Debacle Is Not Over

KENNETH ROGOFF

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CAMBRIDGE – The tentative deal that was just struck to raise the United States’ debt ceiling won’t make the problem go away. Partisan standoffs over the federal debt limit have become a predictable feature of American political life. And while some blame an ill-conceived rule, that argument misses the point.

The real source of the problem is that politicians today have little incentive to compromise. In an environment of gerrymandered electoral districts and ideologically-siloed traditional and social media (amplified by bots, algorithms, and economic incentives), the instability will only worsen in the foreseeable future. That could mean more frequent government shutdowns or more restrictions on central bank independence. With former US President Donald Trump very much in the mix to return to the White House after the 2024 election, who knows what else.

The idea that hitting the debt limit will force the US to immediately default on its bond obligations is a canard. The government takes in more than enough tax dollars to pay the interest on debt, and the debt ceiling creates no obstacles to rolling over maturing debt as it comes due.

Of course, the government would be constrained from spending above its income, because there would be no way to do that without issuing new debt. So, the Treasury would be pushed into hard choices. Since no one wants to touch Social Security or Medicare, it would become necessary to delay or scale back payments on other items, possibly leading to a partial government shutdown (which would not be the first time).

Nothing would force the US Treasury to stop honoring existing US debt and thrust the global financial system into chaos. This could happen only if the stalemate went on for so long (months?) that political pressures simply exploded.

That is what typically happens in debt-distressed emerging markets, where outright default typically happens long before ability to pay is actually the constraint. Unlike emerging markets, of course, where debts are often denominated in foreign currency and the state’s capacity to tax is sharply circumscribed, the US can issue more debt by waving a magic wand, though spending too much too fast would stoke inflation.

Some of the ideas that have been bandied about to circumvent the debt ceiling are very risky power grabs that could backfire. For example, invoking the Fourteenth Amendment risks being overturned by the Supreme Court. And, much sooner than that would happen, congressional Republicans could refuse to pass basic spending bills needed to keep the government operating. Minting a trillion dollar coin and depositing it at the Federal Reserve in order to circumvent Congress would put the central bank in an untenable position.

The debate has never been about debt; it is about power. If the Republicans sweep into power in 2024 and end up controlling the House, Senate, and presidency, there is little question they will want to pass a large tax cut, steepening the trajectory of debt. If Democrats take back the House, and keep the presidency and Senate, there is little question they will want to use debt finance to expand the footprint of government.

Conservatives think deficits caused by tax cuts don’t matter because they incentivize work and entrepreneurship, thereby generating sufficient growth to repay debt later. Left-leaning economists argue that even without such incentive effects, growth is likely to outstrip interest payments most of the time, so the debt burden never becomes anything meaningful to worry about.

Both sides’ idea that debt is always free as long as it is used the “right” way is stupefyingly naive. Real (inflation-adjusted) interest rates had fallen sharply after the 2008-09 financial crisis, stayed low throughout the ensuing decade, and fell sharply again during the pandemic. But now, forward-looking measures of real interest rates, such as ten-year inflation-indexed government bonds, are far higher today across the advanced economies than they were during the pandemic years. Moreover, the world has become more unstable, and it is extremely likely that many Western countries will need to raise spending on defense, placing further strains on budgets.

To hear unabashedly Democratic commentators tell it, the Republicans are 100% to blame for the recent stalemate. That is true. It is also true that President Joe Biden campaigned as a centrist, then used two years with razor-thin legislative majorities to pass generational changes in policy that promise to affect the country for years. The Republicans want to revisit some of these changes.

Democrats object that the Republicans are trying to prevent the government from borrowing to cover spending that Congress has already approved. That is nonsense; the government can always revise its long-term spending plans. But an effective government should be able to find ways to reach long-term spending agreements that are not subject to constant re-evaluation.

The latest last-minute deal to raise the US debt ceiling does not do that. On the contrary, with the country on track for a Biden-Trump rematch next year – a contest that Trump just might win – any truce is likely to be short-lived.