The debt ceiling episode

The United States federal debt limit probably reached its zenith. The debt due to Covid spending has increased approximately by 2 trillion from 26 trillion to 28.4 trillion. Congressional leaders need to work on an emergency basis before October, 2021 in boosting the limit. The United States debt-GDP ratio of over 100 percent is a concern among the developed world as this exceeded the OECD recommended debt-GDP ratio of 77 per cent. The debt-GDP ratio is hovering over 100 per cent from 2015 and accentuated due to GOP tax cuts during the Trump administration. Janet Yellen, now the Treasury Secretary and who previously headed the Federal Reserve System or the Fed in a letter to congressional leaders, seeks broad bipartisan support to extend the limit to avoid a payments default. “We have learned from past debt-limit impasses that waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating”. The debt accumulates as a snowball effect of the budget deficit and successive administrations should shoulder the responsibility of current stalemate.

The issue of the extension of the debt limit owns historical precedence. Thus Congress authorised borrowing such as construction of the Panama Canal before World War I. The debt ceiling was raised to accommodate accumulating costs for World War II in each year from 1941 until 1945. The establishment of the Federal Reserve System abbreviated as Fed in 1913 was instrumental in setting such a limit to safeguard the sanctity of independence Fed. The rationale for restrictions on federal debt by Congress rests on two planks. First, this authorizes Congress in exercising its constitutional powers of the purse, taxation and designing the myriad instruments through which debt can be financed with any specific requirement such as desirable interest rates or maturity of debt instruments.  Secondly, the unhindered authority of the Treasury Secretary to issue debt instruments may stymie the monetary policy that could affect the interest rate and employment; two principal objectives of monetary policy. Historical data suggests that the United States debt-GDP ratio met the threshold OECD level till 2009 when debt-GDP ratio was 82 percent, exceeding 100 percent level in 2013 and now 108 percent. Thus, the debt limit issue is a perennial practice by which the congress works and keeps an eye on the discipline on government expenditure.

The debt ceiling episode illustrates many features characterized by the structure of Congress, perspectives of the Chair of Fed and the Treasury secretary and the environment; the viewpoint of the House Committee on Ways and Means and  Senate Finance Committee. The last two decades experience provided many insights, guidelines and passage of acts that shaped the future work environment. Debt limit increases in 2005, 2006 and 2007 were less painful but the jolt started in 2008; the debt ceiling episode in 2011 was longer and more contentious compared to those that preceded it. The trouble started with the subprime mortgage episode after the period of Great Moderation. Intervention was crucial to stabilize the financial markets and the Treasury Secretary was authorised by the Congress to buy mortgage-related assets in order to stabilize financial markets.

The passage of the Budget Control Act of 2011 evoked a more stringent measure to cope with the profligacy by caps on discretionary spending and created other means of constraining federal spending. Timothy Geithner the then Treasury Secretary set a specific date August 2, 2011 that the borrowing authority would be exhausted on that date with a debt issuance suspension period which would allow extraordinary measures to extend Treasury’s borrowing capacity.  This suspension issue also   surfaced during both the President Barack Obama and Donald Trump administrations that shook financial markets, credit downgrade of federal debt, consumer confidence and approval ratings for both the presidents and the Congress.

The two-year suspension of the debt limit that Congress agreed in 2019 was reached on August 1, 2021. Now if Congress fails to act by October 18, 2021 and the “extraordinary measures'' enjoyed by the Treasury Department are exhausted, the confidence in the financial structure could be at a stake during this critical moment of nascent recovery and the Treasury would be left with very limited resources to reinstate the supremacy of the economy on a global level. That could even jeopardize the dollar’s status as the international reserve currency.  “A dysfunctional Congress could pose a graver economic threat than the pandemic.” Legislation require that 60 out of 100 members agree on a bill but with Democrats razor-thin majorities, a few votes from Republicans are essential; the issue at stake is though Republicans oppose allowing the U.S. government to default but they insist that the Democrats expunge the word temporary suspension of the debt limit in the bill. It is now only three weeks that the impasse needs to be resolved otherwise “It would be disastrous for the American economy, for global financial markets, and for millions of families and workers whose financial security would be jeopardized by delayed payments.”

It is a unique event in the United States financial management that a person who was the Chair of the Fed is holding the position of Treasury Secretary. Janet Yellen is the first woman to lead the Treasury Department in its 232-year history. She was also the first woman to head the Federal Reserve System. She is now facing an impasse on this issue because of a standoff within Congress. We expect that through her conjugate foci she could survive the impasse and the American economy could be again on the smooth path of recovery to claim supremacy in the global economy.

The writer is the Treasurer and a Professor of Economics, School of Business and Economics, United International University.