Debt Ceiling's Impact is Overrated

The government's debt ceiling has been the focus of heated debate in Washington, as many economists, politicians, and pundits buy into the notion that the debt ceiling must be raised to avoid economic disaster.  The reality is that many potential catastrophes have been threatening the U.S. for years now, as a consequence of our growing debt.  Treating our unhealthy fiscal state with more debt may stave off withdrawal symptoms for a while, but the underlying addiction to spending remains, and grows worse by the day.

Despite the fact that a debt ceiling increase only provides temporary, superficial respite, many of those who favor such a move give too much weight to the impact of the debt ceiling.  In a recent op-ed in the Washington Post, Virginia Senator Mark Warner argues, "Failing to raise the debt ceiling will increase interest rates, gut consumer confidence, and drag down business investment and job creation."  The notion that changing an artificial construct like the debt ceiling will have such a massive impact on real economic conditions comes from viewing the economy in the abstract.  Rather, the economy is comprised of people who engage in millions of exchanges every day.  Because the economy is not an abstraction but is very real, it is unlikely that an arbitrary debt limit would dramatically affect real economic conditions.  Some parts of the doomsday scenario posed by officials like Senator Warner, Treasury Secretary Tim Geithner, and the president may well come to pass: rising interest rates, consumer confidence falling, job creation declining.  However, it is not likely to be the sole result of a failure to raise the debt ceiling, as we already see many of these symptoms occurring.

A good example is the case of interest rates.  It is claimed that without increasing the debt ceiling, the U.S. would default on some of its loans and its credit rating would take a hit.  As a result, interest rates would rise, as lenders charge a risk premium for the added possibility of default.  Raising the debt ceiling does not remove this threat, and it will continue to be a threat if the debt and the government spending fueling it are not contained.  By raising the debt ceiling and not addressing the debt problem, government borrowing continues to rise, the demand for money rises in the loanable funds market and interest rates rise, anyway.  This is why Moody's has been widely cited for threatening to downgrade America's credit rating should the debt ceiling not be raised, yet they also say they may well do the same should the debt not be contained.

If investors believe the government will not continue binge spending after the debt ceiling is raised, and that the possibility of default is low, interest rates would remain low.  However, investors have an incentive to be knowledgeable about the investments they make, and they know that as government spending continues to rise, the riskiness of lending to the government rises as well.  The powerful internal forces of the market will ultimately determine interest rates.  This is not to say that the debt ceiling shouldn't be raised, but to suggest to the American people that the sky will fall without raising the ceiling is dishonest and bad economics.  Though, the sky will fall eventually if the true debt problem is not addressed.

Politicians must take meaningful steps to bring about economic recovery.  Economic growth occurs best when people are left to their own devices, not when government engineers the process by raising the debt ceiling here, expanding the money supply there, and raising taxes somewhere else, and any serious plan for economic recovery must acknowledge this reality.

Structural budget reforms must be made in order to restore long-term economic growth, including dramatic cuts in federal spending, a restructuring of entitlement programs, and the realization by Senator Warner and others in Washington that the economy is not a game of chess, but the ongoing product of the hard work of millions of Americans, and is far too complicated for effective bureaucratic intervention.  Otherwise, we risk seeing an increased debt ceiling absent serious spending reform; and will face downgrade and default once again.  Raising the debt ceiling is not an easy way out of meaningful budget reform; it is simply a sign that our nation's spending addiction is winning the battle, and that Washington is failing to administer the required treatment.

Zebulen Riley is an associate policy analyst with the National Taxpayers Union Foundation (www.ntu.org/ntuf).

The government's debt ceiling has been the focus of heated debate in Washington, as many economists, politicians, and pundits buy into the notion that the debt ceiling must be raised to avoid economic disaster.  The reality is that many potential catastrophes have been threatening the U.S. for years now, as a consequence of our growing debt.  Treating our unhealthy fiscal state with more debt may stave off withdrawal symptoms for a while, but the underlying addiction to spending remains, and grows worse by the day.

Despite the fact that a debt ceiling increase only provides temporary, superficial respite, many of those who favor such a move give too much weight to the impact of the debt ceiling.  In a recent op-ed in the Washington Post, Virginia Senator Mark Warner argues, "Failing to raise the debt ceiling will increase interest rates, gut consumer confidence, and drag down business investment and job creation."  The notion that changing an artificial construct like the debt ceiling will have such a massive impact on real economic conditions comes from viewing the economy in the abstract.  Rather, the economy is comprised of people who engage in millions of exchanges every day.  Because the economy is not an abstraction but is very real, it is unlikely that an arbitrary debt limit would dramatically affect real economic conditions.  Some parts of the doomsday scenario posed by officials like Senator Warner, Treasury Secretary Tim Geithner, and the president may well come to pass: rising interest rates, consumer confidence falling, job creation declining.  However, it is not likely to be the sole result of a failure to raise the debt ceiling, as we already see many of these symptoms occurring.

A good example is the case of interest rates.  It is claimed that without increasing the debt ceiling, the U.S. would default on some of its loans and its credit rating would take a hit.  As a result, interest rates would rise, as lenders charge a risk premium for the added possibility of default.  Raising the debt ceiling does not remove this threat, and it will continue to be a threat if the debt and the government spending fueling it are not contained.  By raising the debt ceiling and not addressing the debt problem, government borrowing continues to rise, the demand for money rises in the loanable funds market and interest rates rise, anyway.  This is why Moody's has been widely cited for threatening to downgrade America's credit rating should the debt ceiling not be raised, yet they also say they may well do the same should the debt not be contained.

If investors believe the government will not continue binge spending after the debt ceiling is raised, and that the possibility of default is low, interest rates would remain low.  However, investors have an incentive to be knowledgeable about the investments they make, and they know that as government spending continues to rise, the riskiness of lending to the government rises as well.  The powerful internal forces of the market will ultimately determine interest rates.  This is not to say that the debt ceiling shouldn't be raised, but to suggest to the American people that the sky will fall without raising the ceiling is dishonest and bad economics.  Though, the sky will fall eventually if the true debt problem is not addressed.

Politicians must take meaningful steps to bring about economic recovery.  Economic growth occurs best when people are left to their own devices, not when government engineers the process by raising the debt ceiling here, expanding the money supply there, and raising taxes somewhere else, and any serious plan for economic recovery must acknowledge this reality.

Structural budget reforms must be made in order to restore long-term economic growth, including dramatic cuts in federal spending, a restructuring of entitlement programs, and the realization by Senator Warner and others in Washington that the economy is not a game of chess, but the ongoing product of the hard work of millions of Americans, and is far too complicated for effective bureaucratic intervention.  Otherwise, we risk seeing an increased debt ceiling absent serious spending reform; and will face downgrade and default once again.  Raising the debt ceiling is not an easy way out of meaningful budget reform; it is simply a sign that our nation's spending addiction is winning the battle, and that Washington is failing to administer the required treatment.

Zebulen Riley is an associate policy analyst with the National Taxpayers Union Foundation (www.ntu.org/ntuf).

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