6. When was the debt ceiling last raised? In August 2019 the debt ceiling was suspended for two years in a bipartisan budget deal and reinstated on August 1, 2021, at a level covering all borrowing to that date, the dashed line in Figure 1 representing the debt increase over that two-year period. Additional borrowing above the level that went into effect on August 1 has not been authorized.
7. If we were at the debt ceiling on August 1 and nothing happened, why is there a problem? When we hit the debt ceiling, the Treasury is authorized to use “extraordinary measures” that allow the government to continue to temporarily meet its obligations, including suspending Treasury reinvestment in some retirement-related funds for government employees. The additional funding available through these measures is limited. Treasury Secretary Janet Yellen had said extraordinary measures would no longer be able to cover all government obligations as of October 18.
8. What’s the new deadline? The recent increase in the debt ceiling will enable the government to meet its obligations through December 3, with maybe an additional few weeks from extraordinary measures, which have already been depleted.
9. Who won the debt ceiling battle? Markets, the economy and U.S. households and businesses. As for who won the battle politically—we leave to the politicians and voters.
10. What would the Treasury have to do if Congress failed to act in time? Without the ability to issue new debt to pay existing claims, the Treasury would have to rely on current cash on hand and incoming cash, largely from taxes, to make its payments. So, the Treasury would be able to make some payments—just not all of them. As such, the Treasury department would likely have to prioritize its payments, although that could bring legal challenges. Moreover, the longer the delay in raising/suspending the debt ceiling, the harder it would be for the Treasury to make its payments. For a delay of a month for example, it is estimated that the Treasury department could only cover approximately 60% of its obligations. In that instance, severe spending cuts would likely be necessary.
In 2011 and again in 2013, Federal Reserve and Treasury officials developed a plan in case the debt ceiling wasn’t addressed in time. At that time, they determined the “best” course of action would be to prioritize debt payments over payments to households, businesses, and state governments. By prioritizing Treasury debt obligations, it was assumed that the financial repercussions would be minimized. However, given recent comments by rating agencies (more on this below), there’s no guarantee that prioritizing debt payments would stave off severe, longer-term consequences like a debt downgrade or higher borrowing costs. Nonetheless, in order to adhere to the full faith and credit clause within the Constitution, debt-servicing costs would likely be prioritized.
11. U.S. Treasury debt was downgraded in August 2011 because Congress waited until the last minute to raise the debt ceiling. Could we see additional rating changes this time? In August 2011, even though Congress acted before the U.S. was no longer able to meet all its obligations, one of the three main rating agencies, Standard & Poor’s (S&P), downgraded U.S. Treasury debt one notch from AAA to AA+. While the other two rating agencies retained the U.S. AAA rating, they both downgraded the outlook to negative. S&P has maintained that AA+ rating since 2011.
Today, another of the three main rating agencies, Fitch, has threatened to downgrade U.S. debt if the debt ceiling isn’t raised or suspended in time. Further, Fitch has stated that prioritization of debt payments would lead to non-payment or delayed payment of other obligations, “which would likely undermine the U.S.’s ‘AAA’ status.” So even if the Treasury made debt payments on time, the other obligations would be missed and likely result in a rating downgrade. Other rating agencies probably would follow suit as well. Another downgrade by a major rating agency may call into question use of Treasury securities as risk-free assets, which would have major financial implications globally. Of course, don’t forget that after the downgrade in August 2011, investors flocked to long-term U.S. Treasuries.
12. Could failure to address the debt ceiling push the economy into a recession? It would depend on how long the Treasury would have to prioritize payments. If the delay is only a day or two, then it is unlikely the economy would slow enough to actually enter into a recession. Payments that were deferred would be repaid in arrears, so the economic impact would likely be minimal. However, if payment prioritization is necessary over a prolonged period of time—say a month or longer—this could indeed cause economic activity to contract. Since the government is running a fiscal deficit of around 7% of gross domestic product, and the Treasury could not issue debt to cover that deficit, spending cuts would need to take place. In that scenario, according to analysis by Oxford Economics, $1.5 trillion of spending would need to be cut. The spending cuts, if prolonged, would likely push the U.S. economy into recession. Moreover, the unknown knock-on effects, such as the impact on business confidence, would also likely slow economic growth.
13. How would a technical default impact the financial markets? In 2011, which is probably the closest comparison to this year, the S&P 500 Index fell by over 16% in the span of 21 days due to the debt-ceiling debate and subsequent rating downgrade. The equity market ended the year roughly flat, so investors who were able to invest after that large drawdown were rewarded. However, that large drawdown was due solely to the policy mistake of not raising the debt ceiling in a timely manner. It’s likely that if Congress were to wait until the last minute again before raising or suspending the debt ceiling, equity markets would react similarly.