As Washington debates whether to raise the limit on government borrowing, an earlier conflict over the debt ceiling offers a cautionary tale about how brinksmanship can damage the economy.
The U.S. economic recovery was chugging along in the summer of 2011 when a partisan fight broke out over whether Congress would raise the federal debt limit and avoid a national default.
The protracted, unsettling nature of the negotiations between the White House and Republicans dramatically slowed the recovery, economists conclude, looking back at the episode. Consumer confidence collapsed, reaching its worst level since the depths of the financial crisis. Hiring stalled, with the private sector creating jobs at its slowest pace since the economy exited the recession. The stock market plunged, sending the Standard & Poor’s 500-stock index down more than 10 percent.
Now, many economists warn that another powerful blow to the economy could be coming. With the government set to run short of money as early as next month, Republican lawmakers said Friday they would try to pass a bill raising the debt limit but only for three months.
“The debt ceiling debate in 2011 was pretty scary, and it hurt the economy,” said Nicholas Bloom, an economics professor at Stanford University who has studied the relationship between uncertainty about government policy and economic activity. “I think that will happen again, and I’m worried.”
There are already signs that fears about the next debt ceiling battle are holding back economic growth. Like in 2011, Republicans have been insisting that the government slash spending in exchange for a significant increase in the debt limit, which now stands at $16.4 trillion, though they have become more willing to accept a brief increase. President Obama says he wants the limit raised unconditionally and pledges he won’t negotiate over it as he did in 2011.
The Treasury Department says the government will be unable to meet all its obligations at some point between the middle of February and early March unless Congress allows for more borrowing. If it does not, Treasury says the government would default — and most economists say this would severely hurt the economy.
But even a political debate that delays a resolution to the last minute is likely to have harmful effects. “The damage will mount quickly as the day of reckoning approaches,” said Mark Zandi, an economist with Moody’s Analytics.
This week, Morgan Stanley reported that its index of business conditions — a measure of corporate expectations about the state of the economy — plunged. The agreement forged at the start of the year to avert the automatic tax hikes and spending cuts known as the “fiscal cliff” did little to boost confidence.
“With another prolonged, high-stakes political circus expected in the coming months, fiscal policy uncertainty remains high. Business conditions expectations turned lower, and hiring remains subdued,” Morgan Stanley economists wrote in a report.
Also this week, a Federal Reserve study showed that businesses around the country are growing increasingly concerned about the coming congressional debate. The analysis found that businesses were broadly concerned about uncertainty created by government policy.
Because of the uncertainty, economists are lowering their expectations for consumer spending, the main driver of the economy. Consumer spending is already being squeezed because workers are taking home thinner paychecks this year because of the expiration of the payroll tax holiday on Jan. 1.
“If the political bickering over the debt ceiling issue reaches a fever pitch as it did in the summer of 2011, then consumer confidence will nose-dive further into recession territory,” Chris G. Christopher Jr., a senior principal economist with IHS Global Insight, wrote in a report this week.
It is not only the debate over the debt limit that is slowing the economy. Around the same time that the U.S. government is scheduled to run short of money to pay its bills, Congress faces a new deadline to head off automatic spending cuts to domestic and defense spending, which could seriously jar the economy. And later in March, a law that authorizes funding for government operations expires. Without new legislative action, the government will shut down.
“We have three chances within three months of somehow shutting down the government, having a default or having a fiscal contraction,” said Justin Wolfers, a professor of economics and public policy at the University of Michigan. “I’ve been an economist long enough to know that to have that many threats emanating from the government in such a short period of time will have negative consequences.”
In 2011, the debt ceiling dispute traumatized the economy.
A little more than a week before the debt ceiling deadline that year, Scott Davis, chairman of UPS, the shipping and logistics company, warned that the uncertainty was causing “big issues.” He told investors, “Consumer confidence is down because of it, unemployment’s still weak, so a lot of uncertainties right now.”
Paul Huck, chief financial officer of Air Products, a materials conglomerate, shared similar sentiments about the debt limit with his investors.
“You’d have to be blind to not see it. It’s on every news channel and every newspaper,” he said at the time. “So that worries consumers, which then worries a business which has to invest. We aren’t creating jobs and stuff like that.”
During this period, hiring came to a near standstill. In August 2011, companies hired only 52,000 Americans. Until that point in 2011, monthly private-sector job creation had been averaging 184,000.
With only a few days left, Obama and congressional Republicans came to an agreement to increase the borrowing limit. Still, Standard & Poor’s, the credit rating firm, downgraded U.S. government debt, citing the political dysfunction, and budget analysts said that relatively higher interest rates caused by the impasse could cost Americans billions of dollars.