Long debate over debt ceiling could harm economy, reports says

October 3, 2013

The Obama administration warned Thursday that a prolonged debate over whether to raise the federal debt ceiling would harm the economy by depressing business and consumer confidence, increasing stock market volatility, erasing household wealth and increasing interest rates on mortgage and corporate loans.

In a new report, the Treasury Department studied the economic fallout from a similar debt ceiling impasse in 2011 — when the nation came within days of defaulting on its obligations — and said that the country could see similar effects this year if lawmakers wait until the final hours to raise the debt ceiling.

In 2011, according to Treasury economists, “consumer and business confidence fell sharply, and financial markets went through stress and job growth slowed. In 2011, U.S. debt was downgraded, the stock market fell, measures of volatility jumped, and credit risk spreads widened noticeably.”

Given that the ongoing government shutdown is already harming the economy, they warned, the effects this year could be worse.

The Treasury has said the $16.7 trillion debt ceiling must be raised by Oct. 17 to avoid a potential default on the U.S. debt. The debt ceiling is now emerging as the top priority for discussions in Washington even as the government remains shut down for the third day. Republicans are planning to demand concessions to raise the debt ceiling, while the White House and Democrats say it must be increased unconditionally.

The U.S. is the only big country with a debt ceiling. The Post's Karen Tumulty explains why. (The Washington Post)

Failing to do so, Treasury warned, would have catastrophic consequences.

“A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse,” the report said.

The Treasury report explored the economic effects of the 2011 debt-ceiling impasse through multiple channels. The report found that from June through August 2011, consumer confidence fell 22 percent and business confidence fell 3 percent.

What’s more, the stock market — as measured by the Standard & Poor’s 500-stock index — fell 17 percent and was far more volatile in the time surrounding the debt limit debate. In large part as a result, household wealth declined $2.4 trillion. Retirement assets, in particular, declined $800 billion.

Interest rates on a wide range of loans also spiked, with the effects lingering for months. Higher interest rates tend to slow economic growth. Rates jumped by more than half a percentage point on corporate loans, compared to benchmark Treasury rates.

More critically, rates jumped by 0.7 percentage points on mortgages, which the Treasury estimated cost the average home buyer $100 per month in mortgage costs.

Administration officials acknowledged that other factors might also have been influencing the markets – particularly financial distress in Europe.

This year, the economy enters the fiscal showdown with greater strength than in 2011, but the government shutdown already is slowing growth, which could exacerbate any impact from a debt ceiling clash.

Treasury officials said they were beginning to see the impact from the clash in the financial markets, with rates on Treasury bills that are paid back after Oct. 17 increasing recently.

While officials acknowledged that could reverse, they wrote, “if market participants were to lose confidence in the United States’ willingness to repay its debts, the adverse effects seen in 2011 could reappear, and even push up yields on Treasury securities. Such a rise in Treasury yields would also raise the cost of financing the government’s debt and worsen the fiscal position of the government.”

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