The debt ceiling is the limit on how much money the federal government can borrow. Or to be more precise, the amount the federal government can add to the total of cumulative debt outstanding from past years. As history shows us, the debt ceiling serves no useful purpose and should be eliminated.
Prior to 1917, the United States did not have a debt ceiling. At the onset of World War I, Congress created a debt ceiling and allowed the Treasury to issue bonds and take on other debt without specific Congressional approval, as long as the total debt fell under the statutory debt ceiling. In the era when the debt ceiling law was passed, economists believed that the economy was self regulating and that it always tended toward full employment in the long-run.
The idea that aggregate demand could be too little and that the economy could languish in a recession for decades were eventually accepted as an economic fact of life largely due to the writings of John Maynard Keynes who advocated for the use of deficit spending, in the form of government expenditures, to restore demand and push the economy to full employment.
During the 1940s the prevailing view among economists was that taxation followed expenditures. In other words, Congress decided what expenditures were needed and then determined what taxes would be imposed to accomplish Congressional intent, with debt financing reserved for extraordinary economic circumstance, such as a depression or war.
Since 1917 the debt ceiling has been raised 100 times. The debt ceiling was raised 74 times from 1962 when Kennedy was president to 2011 when Obama was President. In practice, the debt ceiling has never been enforced, even though the public debt itself may have reduced.
The fact that it has never been enforced does not mean that Congress, in its efforts to get a bipartisan agreement to avoid reaching the debt ceiling in the future, didn’t agree on, or consider, legislation that was equally as damaging as enforcing the debt ceiling.
Congresses first misguided effort was President George H. W. Bush’s Pay As You Go (PAYGO) plan. PAYGO was a budget rule requiring that new legislation that affects revenues and spending on entitlement programs (taken as a whole) not to increase projected budget deficits.
There is widespread agreement that PAYGO worked extremely well when the economy was expanding and shrinking budgets were the order of the day, but just as soon as another recession appeared, the inability to expand demand through deficit spending, which was strictly prohibited by PAYGO, lead to the law being allowed to expire in 2002.
A second misguided effort at avoiding a debt ceiling crisis was the recommendation from Simpson-Bowles Commission. The commission recommended a cap on both spending and revenue at about 21 percent of GDP. According to the Commission’s estimates, the Simpson-Bowles plan would have brought publicly held debt back to about 62 percent of GDP within 10 years and to 40 percent by 2037.
Fortunately this plan was never made into legislation. Capping expenditures at 21 percent would have effectively killed any expansionary fiscal policy legislation designed to offset a recession.
Under Simpson-Bowles, Biden’s pandemic recovery legislation would not have been impossible, as well as prior efforts at expanding unemployment compensation. Worse, efforts to reduce the national debt would have resulted in either expenditure cuts, tax hikes or both, any combination of which would have sent the economy into a depression. Even conservative economists agree that trying to pay down the national debt is economic suicide.
The U.S. has never defaulted on its debt obligations, which is a major reason the U.S. can borrow money readily and at the lowest rates. If the ceiling isn’t raised, the Treasury, as some point, will be forced to delay interest payments on government debt. Such an outright default on Treasury securities would damage the Treasury securities markets’ ability to borrow resulting in significant interest rate hikes for government bonds, mortgages, household and business loans.
In addition to the damaging effect on mortgage lending, household spending and investment, higher interest rates will depress bond prices resulting in a huge loss in financial wealth. On the international level higher interest rates lead to capital inflows which deprive foreign nations of the financial capital they need for investment, which could trigger a global recession.
Even worse, if the federal government does hit an enforced debt ceiling, it would leave the government unable to make payroll, make government purchases, transfers, Social Security, Medicare and all other forms of federal obligation.
In short, enforcing the debt ceiling would wreck the economy faster than the 2008 financial crisis, for no identifiable reason other than debt ceiling proponents wanted it so.
Gary Latanich, Ph.D., an emeritus professor of economics at Arkansas State University, can be contacted by email at firstname.lastname@example.org.