The White House’s Council of Economic Advisers (CEA) warned earlier this month that a US debt default could cause a 45% drop in the stock market and a catastrophic recession similar to the 2008 Great Financial Crisis.
New analyses by both the Congressional Budget Office and the U.S. Department of the Treasury suggest the United States is rapidly approaching the date at which the government can no longer pay its bills, also known as the “X-date.”
History is clear that even getting close to a breach of the U.S. debt ceiling could cause significant disruptions to financial markets that would damage the economic conditions faced by households and businesses. Real time data, indicate that markets are already pricing in political brinkmanship related to Federal government default through higher risk premia.
Brookings Institution analysts Wendy Edelberg and Louise Sheiner recently argued that “Worsening expectations regarding a possible default would make significant disruptions in financial markets increasingly probable” and that “such financial market disruptions would very likely be coupled with declines in the price of equities, a loss of consumer and business confidence, and a contraction in access to private credit markets.”
The closer the U.S. gets to the debt ceiling, the more we expect these market-stress indicators to worsen, leading to increased volatility in equity and corporate bond markets and inhibiting firms’ ability to finance themselves and engage in the productive investment that is essential for extending the current expansion.
Should we breach the debt ceiling, the costs to the economy would be likely to be quickly felt. Mark Zandi, Chief Economist of Moody’s Analytics, predicted that even with a brief default, a “crisis, characterized by spiking interest rates and plunging equity prices, would be ignited.
Short-term funding markets, which are essential to the flow of credit that helps finance the economy’s day-to-day activities, likely would shut down as well.” Right after a default, Fitch Ratings reports that “the US’s rating would be moved to “‘RD’ (Restricted Default) [and] affected Treasury securities would carry a ‘D’ rating until the default was cured.”
The costs would be even greater under a protracted default. A CEA simulation of the effect of a protracted default shows an immediate, sharp recession on the order of the Great Recession.
In 2023 Q3, the first full quarter of the simulated debt ceiling breach, the stock market plummets 45 percent, leading to a hit to retirement accounts; meanwhile, consumer and business confidence take substantial hits, leading to a pullback in consumption and investment.
Unemployment increases 5 percentage points as consumers cut consumption, and businesses lay off workers. Unlike the Great Recession and the COVID recession, the government is unable to help consumers and businesses. As the breach continues, the economy heals slowly, and unemployment is still 3 percentage points higher at the end of 2023.