Given that Speaker of the House John Boehner (R-Ohio) essentially promised last week to engineer a replay of last summer’s debt ceiling fight at the first opportunity, people have been wondering if that previous fight could be tied directly to subsequent economic damage in the form of lost output or jobs.
The short answer: maybe.
Before going into this question, however, it is worth noting that there is absolutely zero economic reason to believe that current levels (and expansions in recent years) of public debt are damaging to the economy. We can say this with confidence for a couple of reasons, based in pretty boring textbook macroeconomics. First, interest rates remain historically low, meaning that lenders are not just willing, but intensely eager, to keep financing budget deficits. Second, these low interest rates are not based on capricious market sentiment that could turn on a dime; instead they’re based on economic fundamentals.
To put it quickly, the same thing that is keeping interest rates low is what is keeping the economy weak – an excess of desired savings from households and businesses over demand for new borrowing and investments. So there will be upward pressure on interest rates if and only if this fundamental economic weakness is resolved, and not before.
But while economic fundamentals regarding public debt pose no threat to the U.S. economy, political brinksmanship might. As the nation approached the (arbitrary, unuseful, and dangerous) statutory debt ceiling last summer, what had been historically a pro forma vote to keep the federal government from defaulting on its obligations became this time a chance for GOP members of Congress to extort passage of some of their own pet policies in exchange for not causing an economic crisis. Eventually, the debt ceiling was raised in a deal to cut more than $1 trillion in spending over the next decade.
Given Boehner’s threat/promise of last week, this brings us back to the main question: Did last summer’s political wrangling over the debt ceiling inflict tangible harm on the economy?
Circumstantial piece of evidence exhibit A is that economic growth decelerated markedly in the middle of the year (see figure below on year-over-year GDP growth), roughly as the debt ceiling debate came to a head.
Source: Author’s analysis of Bureau of Economic Analysis National Income and Product Accounts public data series
Further, a paper by Scott Baker, Nicholas Bloom, and Stephen Davis (2012) has attempted to construct an empirical measure of economic uncertainty and estimate the association of rising uncertainty with economic performance. While the paper has often been cited by critics of the Obama administration who think that it estimates the effect of regulatory uncertainty on growth, there is actually almost nothing in the paper to support this reading.
But the paper does show a very large increase in economic uncertainty associated with the debt ceiling fight (see the figure below, which is lifted directly from the paper, including the association of the last spike with the fight over the debt ceiling). In fact, the index of economic uncertainty rose more in the midst of last summer’s debt ceiling fight than it did during the financial meltdown of fall 2008 (when Lehman Brothers collapsed).
Lastly, Baker, Bloom and Davis (2012) estimate that the rise in economic uncertainty as large as the total rise that occurred between the index’s trough in 2006 and its peak in 2011 is associated with a contraction in GDP of more than two percentage points and a reduction in employment of more than 2 million jobs. Eyeballing their chart, the fight over the debt ceiling accounts for nearly half of this 2006 to 2011 rise. If one believes their estimates of the effect of a rise in uncertainty of roughly this size and one is willing to make very strong assumptions about causality (more on this below) this means that the fight over the debt ceiling could have cost the economy a percentage point of GDP and a million jobs (Baker, Bloom and Davis say that these effects manifest between nine and 24 months later).
How hard should we lean on an estimate like this? Not very—the causal relationship between measures of economic uncertainty and performance clearly runs both ways. As Baker, Bloom and Davis note, “So, for example, it could be that policy uncertainty causes recessions, or that policy uncertainty is a forward-looking variable that rises in advance of anticipated recessions.”
Does fighting about the statutory debt ceiling in and of itself damage the economy? Maybe—and it’s clear that the current economy needs no further drags on growth in the coming year.
What’s much clearer is that an actual financial crisis caused by debt ceiling brinksmanship would have real economic consequences, and would also be the first purely self-inflicted sovereign debt crisis in history. Even flirting with this is unspeakably stupid.