While unlikely to occur, a default on U.S. debt would have serious impacts for global financial markets. Learn more.
Lawmakers in Washington set government spending and revenue plans, usually producing a shortfall that many of us know as the federal budget deficit. The debt ceiling limits the amount of borrowing that can take place to pay for the deficit and all the deficits before it.
The government’s borrowing authority is separate from its spending authority, although the two often create political tension at the same time. Typically, the debt ceiling is raised without much fanfare, but occasionally it’s used as a negotiation point within larger political debates.
While the Treasury can employ what are called “extraordinary measures” to fund the government as the debt ceiling nears, at some point, the ability to use these measures would run out.
Treasury Secretary Janet Yellen points to October 18 as the likely date beyond which the government would not be able to meet its debt obligations, but other estimates extend the timeline into late October or early November. The deadline remains fluid, but action on the debt limit is looking necessary sometime in October.
Prioritization of debt payments is a probable initial route, but a default would affect the government’s ability to meet its spending obligations, which include Social Security and Medicare in addition to interest payments.
Any missed payments would accrue interest, raising the costs for government functions. Additionally, U.S. debt ratings would likely be downgraded, increasing the cost of borrowing when the debt ceiling would eventually be raised.
A default on U.S. debt has never occurred. However, the U.S. debt rating did experience a downgrade by Standard & Poor’s about 10 years ago in August 2011.
Debt ceiling uncertainty is a negative for equity market participants, and investor confidence would be severely affected by a default. Furthermore, U.S. debt serves as the benchmark for the global bond market. Any disruptions would likely ripple across financial markets in the U.S. and abroad and could lead to a recession, says Chief Economist Scott Brown, Ph.D.
Both Dr. Brown and Washington Policy Analyst Ed Mills view the likelihood as extremely low. Congress has several options for action on the debt limit, and it’s likely that the Treasury would activate other creative policies in order to avoid default. There’s historical precedent for them taking action deemed potentially outside of legal authority but necessary in a crisis, Mills explains. Additionally, unified party control without divided government further lessens the likelihood of a default.
Ultimately, while a default is not expected, it’s likely we’ll see continued short-term uncertainty as the deadline approaches.