How U.S. debt-limit drama has hurt economy

President Biden and Republican House Speaker Kevin McCarthy reached an 11th-hour deal on the U.S. debt limit Saturday that will bring in no new revenue, claw back funds already appropriated to the IRS and for COVID relief, and essentially hold discretionary spending to current levels. Some Republicans and Democrats in both the House and the Senate criticized McCarthy and Biden, saying each conceded too much. Both houses of Congress must pass the legislation, and Biden must sign it into law by Monday when Treasury Secretary Janet Yellen has warned that funds sufficient to pay all the nation’s debts will run out.

Jason Furman, Aetna Professor of the Practice of Economic Policy at Harvard Kennedy School and the Faculty of Arts and Sciences, spoke to the Gazette about the deal and the economic damage the debt-limit drama has already caused. The interview has been edited for clarity and length.

Q&A

Jason Furman

GAZETTE: What do you think of the deal Biden and McCarthy reached?

FURMAN: The process that led to the budget/debt limit agreement was terrible and harmful. The outcome itself is perfectly fine and represents something in between what the Republicans wanted and the president wanted. And that’s what you get in a divided government.

We’ve gone through debt-limit dramas about once a decade for 40 years now. This one had the largest set of financial market turbulence associated with it of any of the ones we’ve gone through as measured by, for example, market pricing of insurance against the default on U.S. debt or distortions in the interest rates on different treasury bonds. There have been other times when we have seen those react in the run-up of the debt-limit binding. But in this case the movements were much, much larger than before. There’s also, we can’t quantify this, but businesses and certainly policymakers put a lot of effort into contingency planning. Banks, financial institutions had to spend a lot of time worrying about what would happen if we hit the debt limit, time that basically is a deadweight loss.

GAZETTE: What’s different about this debt-limit negotiation that’s caused such turbulence?

FURMAN: It’s that the House Republicans started with an extreme position in terms of wanting to see the president undo major parts of what he had accomplished in his first two years. And the president took a harder line of not being willing to start negotiations until he heard more desire to compromise than appeared to be the case initially.

GAZETTE: The deal itself doesn’t raise any revenue and keeps spending fairly flat or cuts it slightly over 2023 levels, if inflation is factored in. Other than preventing the U.S. from a default, does it boost the economy or reduce the national debt?

FURMAN: The Congressional Budget Office has scored the bill and found over $1 trillion in savings. But it is important to understand that this a score of the legislation itself. The actual savings will depend on whether and how Congress adheres to it. The side deal that was made as part of the debt limit and budget agreement would reduce these savings, potentially substantially. From a macroeconomic perspective, any savings are mildly helpful. It will help reduce inflation over the next year or two; it will take some of the burden off interest rate increases, which will also be a small reprieve for financial stability and the banks; and it will put the debt on a tiny bit better trajectory. All of those macro benefits are real, but small.

On the other side, this is just about the last way that I would reduce the debt. It cuts a nebulous pot of spending called “non-defense discretionary spending” below inflation. That’s where education, research, training, lots of things that I think are quite important, are housed. I would have much rather have achieved the same deficit reduction through some combination of tax increases or reforms, and reduction to spending on entitlement programs.

GAZETTE: If the bill stalls over the next few days, are we still at risk of default?

FURMAN: If there is a hiccup in the passage of this, we could be in a bad place. Monday, June 5, is when the Treasury has warned we hit the X-date. What happens every day on the week of the 5th and every day until June 15 is the government has a lot more money going out than coming in, a little bit like a household with a checking account where money’s moving back and forth and not quite sure which checks are going to be cashed.

Depending on exactly what payments go out to whom, the [U.S. Treasury] may not have enough money to make full payments. That would be something that’s never happened before and would be quite scary.

Now, if everyone knew it was going to pass on the 5th, and it was just one day you were in this state, they probably have some tricks in their back pocket they could use for a very, very short period of time. But it’s not clear exactly what those tricks are, and it’s something I think most people would rather not find out.

Corporations make estimated tax payments on June 15, so if you made it to June 15, then you could make it to July. The problem is getting from the 5th to the 15th, when all these bills are coming due and taxes are barely coming in. That’s difficult or impossible. And we just don’t know how financial markets would react; we don’t know how the rating agencies would react; but whatever it was, it would be ugly.

GAZETTE: Has any of the anticipatory worry over this already harmed the economy?

FURMAN: Oh, yeah. I think it has, certainly. The last several months have been harmful to the economy. Exactly how harmful, I don’t know and can’t quantify. But just the diverted attention, the higher interest rates, the market falling, the effect on confidence, all of that is bad. Another two or three days of drama is going to add almost no incremental cost to what has already been incurred. The House has a tiny bit more suspense than the Senate. In the Senate, the only issue is that even if 99 senators are willing to have it go forward, one person can slow it down. But they can’t stop it.

GAZETTE: Potential options to avert default included everything from Biden invoking the 14th Amendment to the Treasury minting a $1 trillion coin. Was negotiating with McCarthy the best option the president had?

FURMAN: Yes. The other options were terrible. When I was in the Obama administration, our lawyers generally were of the view that the 14th Amendment was not an available option. Financial markets might not view it as an available option, so they might tank and panic if you invoked it. Ultimately, the Supreme Court would decide. I’m extremely skeptical they would have allowed President Biden to get out of this by invoking the 14th Amendment. I think all the ways out of this were really costly economically and potentially politically too because the president [would have] looked like he wanted to try some new risky scheme he had just invented, and it didn’t work out. Everyone would know exactly who to blame and it would have been him.

GAZETTE: This deal will prevent a debt-limit fight during next year’s presidential election, but doesn’t it set the stage for a repeat in 2025 should Biden win re-election and Republicans retain control of the House?

FURMAN:  When President Trump was in office, I advocated repealing the debt limit, so I’ve been consistent that I don’t think either party should use this. The problem is that the Constitution makes it very clear that Congress needs to authorize debt. And so, I don’t like the situation that puts us in, but unfortunately, that appears to be what the law is. Until there’s some way to change that law, there’s no other option other than to follow the law and ultimately negotiate and try to make those negotiations happen in a normal way rather than the abnormal way we’ve just gone through.