The Fed would step in, of course, as it does in every crisis. It would activate emergency measures discussed in the run-up to prior debt-ceiling crises. It would purchase defaulted Treasury securities and accept them as collateral in its own lending operations, albeit at their now-lower market prices. But this would put the Fed on thin ice. It would find itself in the middle of a political conflict. Democrats would criticize it for shielding Republicans from the consequences of their inaction. Republicans would accuse the Fed of complicity with the Democrats’ “socialist” agenda.
Clever analysts suggest that all this could be avoided if the Treasury simply put interest payments first. It could continue paying them in full as tax revenues arrive, while cutting other outlays by 40%. But this assumes away formidable technical problems. (Think reprogramming the government’s computers.) And if you believe that Congress would be prepared to cut social security benefits and military pay to bail out bondholders, then you live in a political fantasyland.
Some hope remains. The Senate parliamentarian could allow the debt-ceiling increase to be attached to a reconciliation bill passed along party lines. The Democrats could swallow hard and vote for it on that basis, doing what’s right for the country regardless of the electoral consequences.
Or Republican holdouts could reconsider, given the gravity of their actions. Recall how, in the throes of the global financial crisis in 2008, then-U.S. Treasury Secretary Henry Paulson went down on one knee to beg for leadership’s support after Congress rejected his $700 billion financial bailout. He succeeded, and the House passed the measure on a second try, with votes from Democrats and Republicans. But don’t hold your breath. The recalcitrant congressional leader then was the Democratic House Speaker, Nancy Pelosi. Today, it’s the Republican Senate Minority Leader, Mitch McConnell.
Barry Eichengreen is professor of economics at the University of California, Berkeley, and a former senior policy advisor at the International Monetary Fund. He is the author of many books, including the forthcoming In Defense of Public Debt.