Written Testimony of Mark Zandi Chief Economist of Moody’s Analytics, U.S. Senate Committee on Banking, Housing, and Urban Affairs’ Subcommittee on Economic Policy ““The Federal Debt Limit and its Economic and Financial Consequences” March 7, 2023
If lawmakers are unable to resolve the debt limit in time and the Treasury begins paying its bills late
and defaults, financial markets would be roiled. A TARP moment seems likely, hearkening back to that
dark day in autumn 2008 when Congress initially failed to pass the Troubled Asset Relief Program bailout
of the banking system, and the stock market and other financial markets cratered. A similar 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.
It is unimaginable that lawmakers would allow things to get to this point, but as the TARP
experience highlights, they have done the unimaginable before. Yet, if that experience is a guide,
lawmakers would reverse course within a few days and resolve the debt limit impasse to allow the
Treasury to resume issuing debt again and pay its bills. Much damage will have already been done, and
although markets would right themselves, it would be too late for the already fragile economy, and a
recession would ensue.
However, if lawmakers do not reverse course quickly and the impasse drags on for even a few weeks
the hit to the economy would be cataclysmic. Most immediately, the federal government would have to
slash its spending. Say if the debt limit was breached on October 1 and dragged on all month, the
Treasury would have no choice but to cut government spending by an estimated $125 billion. And if
there is no agreement in November, another close to $200 billion in spending would need to be cut. The
hit to the economy as these government spending cuts cascade through the economy would be
overwhelming.
Adding to the economic turmoil would be the loss of consumer, business, and investor confidence.
Political brinkmanship over the operations of the federal government has been frightening for
Americans to watch. In both the 2011 and 2013 debt limit episodes, households were closely attuned to
the political hardball being played in Washington and consumer sentiment slumped. The brinkmanship
is also unnerving for businesses, who will pullback on investment and hiring, and financial institutions,
who will quickly turn more circumspect about extending credit to households and businesses.
The timing couldn’t be worse for the economy as even before the specter of a debt limit breach
many CEOs and economists believe a recession is likely this year. With the Federal Reserve ramping up
interest rates in an effort to quell wage and price pressures, avoiding a recession would be difficult even
if nothing else went wrong. Most leading indicators of recession, including the prescient policy yield
curve – the difference between 10-year Treasury yields and the federal fund rate – point to recession
beginning later this year at about the time lawmakers will be doing battle over the limit.
Based on simulations of the Moody’s Analytics model of the U.S. and global economies, the
economic downturn that would ensue would be comparable to that suffered during the global financial
crisis. That means real GDP would decline beginning late this year and through much of 2024, falling
over 4% peak to trough, costing the economy more than 7 million jobs, and pushing the unemployment
rate to over 8%. Stock prices would fall by almost a fifth at the worst of the selloff, wiping out $10 trillion
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in household wealth. Treasury yields, mortgage rates, and other consumer and corporate borrowing
rates would spike, at least until the debt limit is resolved and Treasury payments resume. Even then,
rates would not fall back to where they were previously. And the economy’s long-term growth prospects
will be materially diminished. A decade from now, real GDP is almost one percentage point lower than if
there had been a clean debt limit increase, there are 900,000 fewer jobs, and the full-employment
unemployment rate is 0.1% percentage points higher.
