Debt Ceiling

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Definition of Debt Ceiling:

The debt ceiling is the maximum amount of debt a government can legally incur to finance its operations.

Detailed Explanation: 

The debt ceiling should not be mistaken for the national debt. The national debt represents the total amount a country owes its creditors, whereas the debt ceiling limits how much debt the government can accumulate. When government spending surpasses its revenues, it must bridge the cash deficit by raising taxes, printing money, or issuing debt. However, raising taxes is often unpopular among voters and can impede economic growth. Excessive money printing can lead to inflation, particularly when done on a large scale.

To finance its needs, the US government borrows money through issuing bonds. The national debt has steadily increased because the federal government typically borrows more yearly than it repays. The debt ceiling is a legal constraint on the government’s borrowing capacity to cover its operations. Only a few countries, including Denmark, Kenya, and the United States, have implemented such ceilings. As of May 2024, the national debt is rapidly approaching $34.8 trillion. (See US Debt Clock.)

Before 1917, the Treasury had to request permission to issue debt each time it needed to borrow money to pay its bills. The system was inefficient given the mounting operations and cash needs. In 1917, expenses surged as the US entered WWI. At the time, Congress placed limits and dictated the structure of each bond. In 1939, an aggregate limit was established, and Congress eliminated the different limits on types of bonds, making financing government operations more efficient.  

What occurs when the national debt nears the debt limit? Since 1960, Congress has increased the debt ceiling 78 times (US Treasury). Before 1993, raising the debt ceiling was largely procedural. However, since then, the debate has often become contentious, sometimes leading to government shutdowns as Democrats and Republicans use the debt ceiling as leverage to advance their budgetary agendas. Sometimes, when the limit draws closer, the Treasury has been forced to resort to “extraordinary measures” to fulfill financial obligations and gain additional time, though these are only temporary solutions. 

Delaying lifting the debt ceiling has resulted in government shutdowns lasting five days in 1995 and sixteen days in 2013 before the government agreed on a new ceiling or suspension. During such shutdowns, the U.S. federal government suspends non-essential operations, scaling back agency activities and services, and furloughing non-essential workers. Eventually, the government has avoided default by raising or suspending the debt ceiling. 

The repercussions of default would be dire since government spending constitutes over 33% of the US gross domestic product. Millions could lose their jobs, and global markets would suffer. Failure to meet its financial obligations would mark the first-ever default by the US, jeopardizing the longstanding reputation of US Treasury Bonds as risk-free investments because the full faith and credit of the US government back them. A default would make these bonds less attractive to investors, leading to increased interest rates, which, in turn, would affect rates tied to treasuries, such as mortgages. In 2011, a delay in raising the debt ceiling prompted Standard and Poor’s to downgrade the US credit rating from AAA to AA+, and Fitch followed suit in 2023.

In May 2024, the debt ceiling stands at $31.4 trillion, while the national debt surpasses $34 trillion. Is it not illegal for the debt to exceed the ceiling? Indeed, it is, but in December 2021, Congress opted to suspend the debt ceiling until 2025 rather than risk a government shutdown. Suspension means business continues as usual, simply deferring the inevitable increase. The prospect of a government shutdown looms too large. Without a suspension or an increase in the debt ceiling, the government would exhaust its funds to cover essential expenses such as Social Security, Medicare, payments to private contractors, and employee wages.

Negotiating a debt ceiling should occur before passing a budget. It is illogical for Congress to approve a budget with expenditures surpassing revenues, fully aware that spending will soon reach the debt ceiling. Subsequently, threatening a government shutdown by refusing to raise the debt ceiling serves no purpose, as raising the debt ceiling does not grant authorization for additional spending. Instead, the debt ceiling enables the government to fulfill its existing financial obligations, which Congress approved through previous agreements.

Congress should prioritize fiscal responsibility during budget negotiations rather than resorting to the threat of default as a bargaining chip. The potential consequences of default far outweigh any perceived gains.

Dig Deeper With These Free Lessons:

The Federal Budget and Managing The National Debt
Fiscal Policy – Managing an Economy by Taxing and Spending
Monetary Policy – The Power of an Interest Rate

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