CBO's Director On the Debt Ceiling: Defaulting "a dangerous gamble"

July 27th, 2011 by Douglas Elmendorf Congress

In less than a week, according to projections from the Treasury Department, the US government will begin defaulting on some of its obligations unless the Congress and the President increase the statutory ceiling on federal debt. (CBO doesn’t analyze the Treasury’s daily cash management, so we have no independent projection of the date.) The continuing debate about alternative approaches to raising the debt ceiling is taking place against a backdrop of serious ongoing problems with the federal budget and the economy that raise the stakes for decisions about the debt ceiling and budget policy. As CBO provides objective, nonpartisan information and analysis to assist the Congress during this crucial period, I’d like to highlight some of CBO’s work that bears on the various issues at hand.

To begin, the federal government has ongoing obligations under current law to pay money to various people and organizations: the holders of Treasury debt, Social Security beneficiaries, hospitals providing care through Medicare, states expecting matching payments for Medicaid, large and small firms that have provided goods or services to the federal government, federal workers, and many others. (As I’ve discussed earlier, in calendar year 2010, nearly half of federal spending was in the form of transfer payments, with grants to state and local governments and purchases for defense accounting for another one-third between them; the remaining one-fifth was a combination of interest payments and purchases of nondefense goods and services.)

In response to a question in June, I said that defaulting on those obligations of the federal government would be a dangerous gamble. Here’s why:

It is difficult to know exactly what would happen if the federal government were to default on its obligations to debt holdersbecause we have no recent experience of doing so. However, a government that owes as much as ours does, and will need to borrow as much as ours will need to borrow, cannot take the views of its creditors lightly. Even a slight increase in the perceived risk of US government securities would probably raise interest payments by a lot for years to come. If Treasury rates were pushed up by just one-tenth of a percentage point, the government would pay $130 billion more in interest over the next decade (given CBO’s projected path of revenues and non-interest spending under current law, as explained in our January Budget and Economic Outlook). If, instead, Treasury rates rose by four-tenths of a percentage point, the government would pay more than half-a-trillion dollars in additional interest over the next decade.
Moreover, public statements by many financial-market participants and experts have made clear that default by the federal government on obligations to debt holders would be a significant shock to the global financial system and economy. That shock could trigger large swings in stock prices, private interest rates, and the value of the dollar relative to other currencies; it might also generate massive disruptions and damage to the payments system and the flow of credit; and it would probably weaken the economy and reduce output and employment relative to what they would otherwise be. Indeed, the lack of a plan for increasing the debt ceiling may already be hurting household and business confidence, and default would reduce confidence further and increase uncertainty about future government policies, which would lower spending even apart from the effects of changes in asset prices and interest rates.
It is also unclear what would happen if the federal government were to default on obligations other than Treasury debt. As I said in June, debt holders might be unconcerned because the payments due to them would not be directly affected; however, debt holders might conclude instead that if the government is willing to default on some obligations, it could default on its obligation to them next. In any event, the individuals, businesses, and state governments that are owed money under current law and are counting on receiving it would clearly need to deal with sudden and unexpected shortfalls in their own finances.

Pages: 1 · 2

Money and Computing, News and Issues, Employment, Issues, Politics, Government, Senior Women Web, Sightings

CBO's Director On the Debt Ceiling: Defaulting "a dangerous gamble"

More Articles