The United States reached its debt ceiling, the Congressionally-defined limit on the amount of money the federal government can borrow, in January. While the Treasury Department takes “extraordinary measures” to avoid running out of money, political tensions continue to make raising the ceiling a fraught process. With the issue unresolved, Chicago Booth’s Initiative on Global Markets asked its panels of experts in economics and finance to express their views on the potential effects of default, as well as the ceiling’s impact on the long-run size of the debt.
This statement about the potential impact of the federal government missing payments on its debt and security obligations for several weeks, which went to the IGM’s US panel of economic experts, found a big majority in agreement that such an outcome would do substantial damage to financial markets. Some panelists elaborated on their views in short comments accompanying their answers.
Among those who strongly agreed, Darrell Duffie of Stanford (who is also a member of the finance panel) said, “Several weeks of missed payments on Treasury securities would shake confidence in the safe haven status of Treasuries, roil markets, and possibly cause market dysfunction of the sort experienced in March 2020.” His Stanford colleague Kenneth Judd added, “The US has a 200+ year commitment to pay its obligations, with the UK the only other large economy as reliable. World demand for US paper is high, reducing the cost of US borrowing. Any deviation from that could destroy its reputation.”
Among those who agreed with the statement, Bengt Holmstrom of MIT noted, “The effects are uncertain and could erode credibility unpredictably.” Larry Samuelson of Yale said, “Hints that US debt is no longer utterly safe would have far-reaching effects.” And in a remark that resonates with recent comments by Federal Reserve chair Jerome Powell, University of Chicago’s Robert Shimer stated, “The Fed has said that it would not prevent a default, but it would surely attempt to mitigate damage to the financial system. It is unclear how effective that would be.”
Among panelists who said they were uncertain, Robert Hall of Stanford declared, “I question whether it meets the standard of substantial harm.” His Stanford colleague Jonathan Levin suggested, “Seems very possible. But it would be new territory and how it unfolds could matter a lot.” And Jose Scheinkman of Columbia concluded, “The effect will surely be negative but the magnitude is very uncertain.”
On the statement about the potential impact of the federal government missing payments on US Treasury security obligations for several weeks, a majority of the finance panel agreed that it would pose a substantial risk of a global financial crisis.
Many of the panelists who agreed or strongly agreed indicated how a crisis might arise from default on US government debt. Jonathan Parker of MIT explained, “A several-week ‘technical default’ by the US could lead to a significant decline in the demand for Treasury debt over years. Markets, anticipating this shift, could cause a large increase in US interest rates and crash in the dollar, which could cause a financial crisis.” His MIT colleague Andrew Lo observed, “By risking default, the US is injecting risk into the holdings of both domestic and foreign investors. Such investors will respond to this risk as all rational agents do—by holding less US debt, increasing our borrowing cost.”
Chicago Booth’s Stefan Nagel provided more detail on the link to global markets: “Given the role of Treasuries as [a] default-free benchmark in global financial markets, there is a risk of major disruptions (or, possibly, large Federal Reserve interventions to prevent disruptions).” Janice Eberly of Northwestern agreed: “A default on US government debt would disrupt the Treasury market, which underpins global markets with expected safety and liquidity. Costly recent disruptions were not as fundamental as this scenario. There is also potential longer-run impact on US cost of funds and leadership.”
Other panelists who agreed pointed to dangers to the country’s global role. Stijn Van Nieuwerburgh of Columbia argued, “If the US defaults with no quick resolution in sight, it may prove to be a turning point in which it loses its status as the global safe haven currency. What comes next is hard to predict since there is no natural alternate safe haven currency. A financial crisis may ensue.” Booth’s Amir Sufi concurred: “It would definitely be bad for the US in its role as the provider of a safe reserve currency, but the exact way in which it could cause a global financial crisis is harder to assess. The 2011 situation [discussed in this study] offers a guideline, although debt limit there wasn't hit.”
Further panelist comments explore the uncertainties around possible outcomes. Chicago Booth’s Ralph Koijen replied, “While the magnitude of the disruption will presumably depend on how long this is expected to last, there seems to be a significant risk to Treasury markets that are very central to broader financial markets.” Laura Starks of the University of Texas at Austin added, “The uncertainty surrounding the missed payments and any resultant effects will depend on a number of factors, most particularly, how investors think about the missed payments and the reputation of the safety of US Treasury obligations.”
Among finance panelists who said they were uncertain, Matteo Maggiore of Stanford remarked, “It would certainly not be a positive event, but the details would matter. It mostly would introduce an ‘incompetence risk premium’ into Treasuries by making it clear that the political system is now so dysfunctional that even the federal debt repayment can be used for bargaining.” John Campbell of Harvard commented, “Missing Treasury payments would certainly increase the risk of a financial crisis, but I think a crisis remains unlikely even in that scenario. The downside is so extreme that it is important to avoid this situation.”
John Cochrane of Stanford went further: “Delaying payments for weeks would cause problems, but not obviously a huge crisis. Regulators would quickly allow Treasuries as collateral anyway. Not good, not known, big uncertainty, but could be Y2K. That Treasury cannot issue more debt to offer bailouts might be bigger.” The one panelist who strongly disagreed, Campbell Harvey of Duke, protested: “There are plenty of actions that can be taken to reduce the risk of a default. More importantly, this would be a ‘technical’ default. The US is not in distress and it is very unlikely that a technical default would trigger a global financial crisis.”
On the second statement put to the economics panel—about whether the federal government missing payments on all of its obligations for several weeks would lead to substantially lower employment within six months—there is much more uncertainty in the opinions.
Among those who agreed, Larry Samuelson responded, “This one is less clear, but it is possible that the turmoil in the financial markets would spill over into significant real effects.” Bengt Holmstrom concurred, “If instability in credit markets ensue, there would be spillovers to labor markets,” while Kenneth Judd warned: “The short-run impact may be small. The major dangers are the long-term consequences.”
Chicago Booth’s Anil Kashyap (who is also a member of the finance panel) explains how default might affect the real economy: “Certainly in the first few months there would [be] a lot of damage to the economy, imagine people really not getting Social Security checks . . . There will be some recovery by six months; if interest rates are permanently higher then the damage could still be evident six months later.”
Among those who said they were uncertain, Daron Acemoglu of MIT objects: “Unlikely to see such strong employment effects in such a short time. But uncertain overall.” Robert Shimer cautioned, “This depends on how effective the Fed is at preventing damage to the financial system. Missed payments could be catastrophic, or they could have only a transitory impact on the economy.” Robert Hall disagreed with the statement, pointing to his research with Marianna Kudlyak.
The IGM’s previous poll on the debt ceiling, conducted with the economics panel in early 2013, found broad agreement that the ceiling creates additional uncertainty and risk.
Of those who strongly agreed, Angus Deaton of Princeton said, “It does indeed provide some brake on long-term spending, but there has to be a better way.” Booth’s Kashyap added, “Deciding whether or not to pay the debts incurred to fund the previously approved tax and spending is nuts.” And his Booth colleague Richard Thaler concluded: “The debt ceiling is a dumb idea with no benefits and potentially catastrophic costs if ever used.”
Among those who agreed, Darrell Duffie noted, “This is a second chance to gridlock. A budget passed by Congress already authorizes the necessary funding.” Kenneth Judd remarked, “In the past, it was not acceptable for legislators to create the disruption from blocking a debt increase. Even RR [Ronald Reagan] disapproved.”
The only panelist to disagree in that poll was Chicago Booth’s Luigi Zingales, who argued, “It can also lead to potential better outcomes.” While he agreed with the statement, Peter J. Klenow of Stanford assented to the suggestion of potentially better outcomes: “It sure looks like it's been adding uncertainty lately (e.g. 2011). But it could conceivably be a force for good.” He added links to relevant data and arguments.
In its most recent polls, the IGM asked both panels whether the requirement to periodically increase the debt ceiling measurably reduces the long-run size of the debt. Overall, across both panels (and weighted by each expert’s confidence in their response), nearly three-quarters of panelists disagreed or strongly disagreed.
Among the minority who agreed, John Cochrane said, “It's popular to deny this, but in my view it has some effect. The regular budget process is completely broken. This is one deadline that forces some spending/tax compromises. Not as much as we might like, but would be worse without this last overall budget mechanism.” John Graham of Duke suggested, “The ceiling imposes some discipline . . . but in the end costs are not reduced too much via the debt ceiling process.” And Campbell Harvey proposed, “It is a constraint—but the constraint is usually not binding. We don't know what the debt would be today in the counterfactual (no debt limit). The US has a structural deficit. Why not develop a strategy to fix that rather than just focusing on raising the limit?”
David Autor of MIT also agreed, remarking: “I'm not endorsing the nuclear approach to deficits, but it seems plausible that Republicans’ ability to hold Democrat administrations hostage over the debt ceiling extracts some meaningful budget concessions. Republicans didn't use this power with Trump. Selective concern and hypocrisy abound.”
Among those who said they were uncertain, Daron Acemoglu stated, “There are both positive and negative effects, but overall it's a very inefficient way of managing public debt,” while Robert Shimer observed, “As is, the debt ceiling debates do have an impact on spending, as seen during the ‘fiscal cliff’ in 2013. But without a debt ceiling, those reductions might happen as part of normal budget negotiation.”
Among those who disagreed or strongly disagreed, Michelle Lowry of Drexel commented, “To this point, there is little evidence of such an effect. However, it seems that it might have a measurable effect in the future, if debt levels continue to increase.” Paola Sapienza of Northwestern added, “Hard to test it empirically but it does not look like.” Chicago Booth’s Steve Kaplan (who is a member of both panels) said, “Debt ceiling has not stopped US debt from growing to record levels.”
Two experts look back at past political tensions around the debt ceiling. Janice Eberly said, “Focus on fiscal issues is needed, but the debt ceiling is usually routinely raised and has not led to focused and lasting reductions in fiscal deficits. Moreover, concerns over political stalemate have the opposite effect, as with the volatility and downgrade in 2011.” And Jonathan Parker pointed out, “Historically, the debt ceiling has been raised each time we have hit it. It is hard to believe debt-to-GDP could have risen even more rapidly. And there are technical work-arounds (that we may yet use) that can allow debt to be issued without increasing its face value.”
Finally, some panelists expressed exasperation with the political process around the debt ceiling—and the potential costs for the country. Andrew Lo declared, “Periodically requiring Congress to engagement in brinksmanship has little bearing on fiscal responsibility. We should pay our bills.” Stijn Van Nieuwerburgh warned: “The debt ceiling has been turned into a political weapon that substitutes for sound budgetary policy-making. It risks eroding the convenience yields that the US has benefited from for decades and that would be very unhelpful to lose right now with debt/GDP near 100 percent.”
Kenneth Judd added, “The main effect in the past has been the silly political posturing that comes with these increases. The expectation has been that the debt ceiling has no real impact.” And Richard Thaler concluded, “It is a stupid rule that serves no useful purpose. I predict it will be solved in the last 24 hours of some deadline.”
All comments made by the experts are in the full survey results—for the economics panel, the finance panel, and the 2013 poll.
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