The U.S. Debt Ceiling is an important part of the federal budget process, as it helps to ensure that the government does not overspend & accumulate too much debt. This article is the second in the series on the subject. In the first part of the article we discussed many things about Debt ceiling/limit & ended briefly explaining about the consequences of the Debt limit. In this article we will explore about the consequences of default, the difference between a debt default & a government shutdown, how policymakers have used the debt ceiling in the past & what steps should be taken to improve it.
U.S. Debt Ceiling
The U.S. Debt Ceiling is a restriction imposed by Congress on how much money that the federal government can borrow. It is an essential aspect of the federal budget process since it helps to guarantee that the government does not overspend & incur excessive debt. Debt default may have serious implications. Not only may it result in higher borrowing rates & slower economic development, but it could also leave millions of people unable to pay their rent or eat enough food.
The following graph shows that the Federal Government makes the Average monthly payment per recipient for Federal programs.
Retirement benefit was received by almost 50 million citizens through the Social Security programme along with 6 million received survivors’ benefits in 2020.
The above graph clearly shows that the average retired Social Security recipient receives $1,600 per month. Among the Social Security benefits received by the households, the retired Social Security make up more than half of household income on average (this is Based on CEA analysis of the 2021 CPS ASEC). In terms of percentage, the households that receive Social Security Benefits are 54 per cent.
If Debt default happens, then these households will get delayed payments or no payments at all. Millions would be unable to pay rent or have food/ starve if the Federal government failed to pay on time or didn’t pay at all.
What is the difference between Debt Default and Shutdown?
When Treasury breaches the Debt ceiling a default occurs. This means the government will be unable to pay all its obligations to its citizens and creditors. This includes all government spending, interest on debt, payments to U.S. bondholders and even mandatory payments.
Whereas Shutdown occurs when Congress fails to pass the appropriation bills that allow government agencies to make new payments. When there is a Shutdown then it means that the Federal government agencies must discontinue all non-essential activities/optional functions till new funding legislation is passed and signed into law. However, during Shutdown then essential services and mandatory spending programs will continue their operations.
One of the major differences is a Debt default could be disastrous while Shutdown will be disruptive.
How do policymakers use debt ceiling in the past?
Many times policymakers have enacted “clean” debt ceiling increases, however, Congress has attached the increase with other legislative priorities. There are many instances where Congress attached debt ceiling increases to Budget resolution legislation and other deficit reduction policies. Famous examples are the Gramm-Rudman-Hollings Act in 1985, the Balanced Budget and Emergency Deficit Control Act of 1987 (also called as the Gramm-Rudman-Hollings II), the Budget Control Act of 2011, and No Budget, No Pay Act of 2013.
In most cases the debt limit increase was either attached to deficit reduction measures or a deficit reduction package. However, Congress generally approved temporary increases in the Debt limit. This is to make the negotiations completed with the creditors and to be without the risk of default.
What can a policymaker do (or) how policymakers should handle the debt ceiling?
It is very important for policymakers to understand the severe consequences of the default and act rapidly. The policymakers should work to either suspend the Debt ceiling by the deadline or raise the Debt ceiling. If they fails to do this then it would be completely disastrous.
Even a threat of default can have very serious effects on the economy. Though rising the debt may be a solution it has its consequences too. The rise in Debt will increase the cost burden in future and also reduce fiscal flexibility. Therefore, the policymakers and lawmakers should handle these Debt Ceiling measures with more care. They should also try to address the Debt so that there is no fiscal burden in the future.
The policymakers should not only be aware of the avenues of revenue generation but also should analyse often how it can be increased along with policy reforms, and reduction in government spending. By doing so they can reduce the deficit and always have a sufficient threshold of budget.
The policymakers or lawmakers, whoever is responsible for this, should reform Debt Ceiling/Limit. Instead of a fixed amount the Debt ceiling can be linked as a percentage of GDP.
Why can’t the government just print more money?
Many may think why can’t the Government just print the money and clear all the Debts? Easy isn’t it – no completely wrong. There are two things we need to understand.
First, though the Treasury prints the Dollar (actual bills), the money supply in the economy is handled by the Federal Reserve. One of the objectives of the Monetary Policy is to control the money supply as well as the cost of borrowing in the economy. Therefore, the Federal Government cannot do it on its own without the approval of Congress, as the Federal Reserve do all the monetary policy actions (such as maintaining price stability, controlling interest rates etc… ) only on the Behalf of Congress.
Second, if an economy went to printing money to payoff its Debt, then inflation will rise. As a result of an increase in prices, the value of Bonds will fall, as a result, investors/people will not invest in bonds as thier value is falling. This will result in the non-saleable of Government Securities to finance/pay Debt. Many economies tried to pay Debt by printing money and landed with serious hyperinflation problems – ex. Zimbabwe and Germany.
What are the steps to improve the Debt Ceiling?
Improving debt is one of the important issues/things which any economy should think about (not only the US). The following are a few suggestions
- Fiscal Targets: Linking the Debt limit to fiscal targets. This will enhance not only the budgetary framework but also will save the time of Congress not raising the limit.
- No Fixed Amount: As stated above instead of fixed amount the Debt ceiling can be linked as a percentage of GDP.
- Reducing Debt: Reducing the Debt itself is one of the best ways. By spending only on essential and productive government spending, this can be achieved.
- Increase income base: By increasing the income base will solve this problem to a greater extent.
- Economic Growth: With strong economic growth any economy can handle debt
- Limit Future debt: Limiting the Future Debt obligations is one of the best ways to limit Debt.
Conclusion
The U.S. Debt Ceiling is a limit set by Congress on the how much money that the federal government can borrow. By setting a limit on the amount of money that the federal government can borrow, the debt ceiling plays an important role in helping to keep the nation’s finances in balance. It is important for Congress to examine the implications of raising or lowering the debt ceiling, as changes to the limit can have far-reaching consequences on the U.S. economy. Policymakers must also consider the potential consequences of defaulting on debt, as this could have disastrous effects on the economy. Improving the debt ceiling should involve fiscal targets, linking the limit to a percentage of GDP, reducing debt, increasing the income base, driving economic growth & limiting future debt obligations.