A recent tentative deal on raising the US debt ceiling won’t solve the problem. The partisan dispute over the debt ceiling is a long-standing one in the United States. If some attribute this to false norms, this argument misses the point.
The root of the problem is that politicians today lack the motivation to compromise. In the context of fraudulent constituencies and ideologically driven traditional and social media (augmented by bots, algorithms and economic incentives), instability will increase in the future. This could lead to more government shutdowns or further curtailment of central bank independence. Chances are that former President Donald Trump will return to the White House after the 2024 election, and who knows what’s to come.
The notion that hitting the debt ceiling would immediately stop the US from servicing its bond obligations is false. The government collects enough taxpayer money to pay the debt interest, and the debt ceiling is no barrier to rolling over maturing debt.
America, as if by magic, could carry more debt
Of course, this would prevent the government from spending more than it takes in, as this would be impossible without taking on new debt. So the Treasury will be forced to take tough decisions. While no one wants to shake up Social Security or health insurance, payments for other things will have to be postponed or cut, leading to a partial government shutdown (which wouldn’t be the first time).
“The government collects enough taxpayer money to pay the interest on the debt, and the debt ceiling is not a barrier to extending maturing debt.”
Nothing would compel the Treasury Department to stop servicing existing debts and throw the global financial system into chaos. This will only happen if the standoff lasts long enough (months?) that the political pressure simply explodes.
This usually happens in indebted emerging markets, where defaults usually occur long before solvency actually becomes a problem. Unlike emerging markets, where debt is often denominated in foreign currencies and governments’ ability to collect taxes is much lower, the US can magically borrow more, even as high spending fuels inflation very quickly.
A trillion dollar coin
Some of the ideas that have been published about avoiding the debt ceiling are such dangerous conflicts that they could backfire. Republicans in Congress may refuse to pass basic spending legislation needed to keep the government running. Creating a trillion dollar currency and depositing it with the Fed to bypass Congress would leave the Fed in an untenable position.
The debate is not about debt, but about power. If Republicans come to power in 2024 and control the House, Senate and White House, they’ll want to pass a big tax cut that will fuel more debt. If Democrats recapture the House of Representatives and retain the presidency and the Senate, they will no doubt want to use debt financing to increase government influence.
Conservatives believe that deficits caused by tax cuts don’t matter because they stimulate jobs and entrepreneurship, thereby generating enough growth to pay off the debt. Left-wing economists argue that even without such stimulus effects, most of the time growth exceeds interest payments, so debt burdens are not a significant problem.
“Free” credit
The notion on both sides that credit is always free as long as it is used in the “right” way is surprisingly naive. Real (inflation-adjusted) interest rates fell sharply after the 2008-09 financial crisis, remained low over the next decade, and fell sharply again during the pandemic. But today, forward-looking measures of real interest rates, such as 10-year inflation-linked government bonds, are much higher in advanced economies than in the pandemic years. In addition, the world has become more unstable, and many Western countries may have to increase their defense spending, making budgets even more difficult.
If outspoken Democratic commentators are to be believed, Republicans are 100% responsible for the latest conflict. This is true. It’s true that President Joe Biden campaigned as a centrist and then used two years with razor-thin majorities in the Legislature to spur generational policy changes. Republicans want to reverse some of those changes.
Democrats counter that Republicans are trying to prevent the government from borrowing to cover spending that Congress has already authorized. This is foolish because the government can revise its long-term spending plans at any time. But effective government can find ways to create long-term spending agreements that don’t require constant reevaluation.
The latest last-minute deal to raise the debt ceiling cannot do this. Instead, with the country poised for a repeat of the Biden-Trump showdown next year—a contest Trump could win—any truce is likely to be short-lived.
Kenneth Rogoff is Professor of Economics at Harvard University. Copyright: Project Syndicate.
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– The debt ceiling debacle isn’t over yet
Any federal budget arrangement will likely be short-lived as the US prepares for a repeat of the Biden-Trump fight next year.
Kenneth Rogoff