The High Stakes “Debt Ceiling” Game

Posted by Jeffrey Brown on Jan 10, 2011

Filed Under (U.S. Fiscal Policy)

Debt has always been a part of the American way of life, from the days of the Revolution to the present day.  With the current economic crisis, the amount of debt we are in as a country has become a popular talking point.  While the current debt level is unprecedented, it is worth noting that not since Andrew Jackson was in office has the nation been completely free of debt … and even that was short lived.  In 1917, the Second Liberty Bond Act established a debt ceiling prescribing just how much the government could borrow.  Ever since then, the debt ceiling has been raised as needed: this has happened seven times over the past five years.  Last Thursday, Treasury Secretary Geithner announced that the Federal government would hit the current ceiling soon – possibly as early as March and quite likely by May – so that Congress will need to raise the limit again. 

 The newly seated ‘Tea Party” Congress was elected largely under the promise of restricting government spending.  As part of this, much has been made about possibly refusing to pass an increase in the debt ceiling, leading Obama’s Chairman of the Council of Economic Advisers, Austan Goolsbee, to warn of “catastrophic” consequences.  Austan Goolsee is a terrific economist, and while we do not always agree on policy, I think he is right on this one. 

 However, as the old saying goes, drastic times call for drastic measures. There seems to be a widespread understanding that our deficit-laden fiscal policy is unsustainable and threatens the future of our economic well-being.  Yet there has so far been virtually no meaningful action in addressing it.  Like it or not, we cannot continue to have a split personality on fiscal policy – one with a Republican tax policy and a Democratic spending policy. 

 The need to restore fiscal sanity is the real issue here – in a rational world, the debt ceiling debate would be little more than a high-stakes side show.  We are already 14 trillion dollars in debt, and we are projected to add trillions more over the coming years.  Simply refusing to raise the debt ceiling creates a financial crisis without necessarily addressing the root of the problem – the need to cut spending and/or raise revenue. 

 Rather than fighting over the debt ceiling, what we really need politicians to do is get serious about entitlement reform.  With seniors living longer, a shrinking ratio of worker to retiree, and ballooning health care costs, we are on a path to see Medicare, Medicaid and Social Security overwhelm the federal budget.  

So why have a debate on the debt ceiling?  Because, perhaps, it is a way to stimulate necessary reforms.  A week ago on Meet the Press, Lindsay Graham had this to say, “This is an opportunity to make sure the government is changing its spending ways. I will not vote for the debt ceiling increase until I see a plan in place that will deal with our long-term debt obligations.”  He sent on to say “if we’re serious about taking America in a new direction and you’re not putting entitlement reform on the table, you’ve missed a great opportunity to change the course of America’s future.”  He’s right.

 Currently our debt is equal to 94% of our GDP.  This is up from just 64% in 2007.  Projections have the debt rising to 600% of GDP within just two generations.  The last time the debt-GDP ratio was this high was 1949, largely owing to the fact that we were just a few years beyond WWII.  

Given this, I can understand the attraction of engaging in high-stakes brinkmanship over the debt ceiling if it helps avoid a full-blown economic crisis further down the road.  However, to use a game theory term, one has to wonder if this threat is really credible.   If our desire is to avoid and economic and financial crisis in the future, is it really believable that Republicans are willing to risk causing a financial crisis in 2011 by failing to raise the debt ceiling?  I would hope not.  But if it can be “just credible enough” such that it helps stimulate action on deficits, then it is possibly a game worth playing.