EconExtra covers a news headline about Economics that might be worth a bit of a detour in an economics class to bring the real world into the classroom. The looming debt ceiling and fears of the US defaulting on its debt has been headline material for a few weeks, and will continue to hang out there until there is (hopefully) some resolution before we actually hit it. This topic would fall under CEE standard 20: Fiscal and Monetary Policy.

Headlines

• What the federal debt ceiling showdown could mean for you. (CNBC)
• White House rules out concessions over debt ceiling while GOP refuses to help avert crisis. (WAPO-subscription may be required)
• House clears stopgap measure to avert shutdown and suspend debt ceiling (CBS)
• The U.S. could run out of cash to pay its bills by October 15, analysts say. (NYT-subscription may be required)

The headlines and the resolution of the issue are politically charged.  Here we will focus strictly on a little history and the mechanics of the debt ceiling, and explain what happens if the debt ceiling is not increased and the US defaults on its debt.

History

The US has had public debt since the Constitution was ratified in 1789. Prior to 1917, there was no debt ceiling. Instead, every spending bill presented to Congress had an accompanying financing bill, allowing the Treasury to issue debt to the extent the expenses weren’t covered by other means. This got a little clunky and was not the most efficient way to finance a nation.

World War I brought the first change to that process. The Second Liberty Bond Act of 1917 allowed the Treasury to issue debt without getting Congressional approval for each tranche of debt, as long as total debt stayed below the set ceiling for the different types of debt. This was still a little clunky, and was why there were so many different types of bonds issued to finance WWI and the period after. In 1939, Congress modified this to be a ceiling on aggregate debt as it is today.

The Treasury has the authority to issue debt of various types and maturity as needed to fund spending that Congress has already authorized. (The Treasury does not authorize any new spending.) The debt ceiling has been raised 78 times since the 1960s, agreed to by governments led by both parties when necessary. From 1979 until 1995, The Gephardt Bill was in place whereby the Congress increased the debt ceiling every time a budget was passed. The first debt ceiling crisis happened in 1995 when that rule was appealed. Only in more modern times has the issue of raising the debt ceiling become a contentious political issue at times.

(US Treasury Investopedia)

Current Situation

The situation today is that a temporary suspension of the debt ceiling, enacted during the Trump administration in 2019, expired at the end of July. This means that on August 1, the ceiling reverted to the level set in 2019, but cumulative borrowing during the suspension. (At the end of June, this was $28.5 trillion. The ceiling Treasury is dealing with also includes July borrowings.) So basically, the Treasury can’t borrow more on net, and has been taking extraordinary measures to save cash and manage payments without exceeding that total. This can’t go on for very long. Exactly how long depends on the revenues coming in in the form of tax payments, etc.

(CBO) (CRFB source of graph above)

What Happens if Treasury hits the Ceiling?

As the total debt approached the debt ceiling, the threat of default looms large, and can do damage itself. If the Treasury does run out of money and can’t borrow more, it won’t be able to issue Social Security checks to the fifty million seniors who currently get them. It won’t be able to pay any Federal salaries. Tax credits and refunds won’t happen. Interest on debt and debt repayment won’t happen, or at least won’t happen on time (the “default”), the US credit rating will tumble, interest rates for everyone will rise, and we would experience an unprecedented economic   downturn. This is the warning that Janet Yellen delivered to Congress, urging them to increase the debt ceiling post haste.

No one really wants to see this happen. Many misunderstand the situation, and think that increasing the debt ceiling is like writing a blank check for government spending. It is not. It simply allows the government to pay for all the programs and commitments they already approved to be put on the government’s “credit card” from previously approved legislation.

The “dramatic” numbers by which the ceiling will have to increase is driven by the fact that they include all the increase in debt since 2019 (remember all of those pandemic-related rescue plans?) in addition to currently approved spending. Usually, the debt ceiling is increased more frequently, and by smaller increments. Legislators who voted for the rescue plan and are now thwarting an increase in the debt ceiling are in fact saying “oops, just kidding.” And in case you were wondering, other countries do not have debt ceilings and don’t go through this.

(WSJ-subscription may be required) (CNBC summarized Yellen’s WSJ op-ed)

In the Classroom

For Personal Finance teachers, the debt ceiling and threat of default could start a number of different conversations. For example, you could draw parallels to running up a credit card balance. For both PF and Economics teachers, working through all the impacts to individuals and the stock and bond markets of a government default would give students an appreciation for how economics in the form of fiscal and monetary policy and our personal financial well-being are linked.

About the Author

Beth Tallman

Beth Tallman entered the working world armed with an MBA in finance and thoroughly enjoyed her first career working in manufacturing and telecommunications, including a stint overseas. She took advantage of an involuntary separation to try teaching high school math, something she had always dreamed of doing. When fate stepped in once again, Beth jumped on the opportunity to combine her passion for numbers, money, and education to develop curriculum and teach personal finance at Oberlin College. Beth now spends her time writing on personal finance and financial education, conducts student workshops, and develops finance curricula and educational content. She is also the Treasurer of Ohio Jump$tart Coalition for Personal Financial Literacy.