I realize the potential federal government shutdown this is more of a politics than economics question, but this is some dish from CNN insider, Dana Bash (via Slate):
I’ve not talked to anybody here who doesn’t think it’s a very, very big possibility, even Republicans, that the government won’t shut down—even for a short time.
I can’t say this with certainty, but I am unsure whether or not I can say that I don’t disagree with Ms. Bash’s observation.
As you may have noticed, Professor Finkler and I are both keeping one eye on the doings in Washington, with the likes of Summers and Roberts weighing in on the deal. To add to that lineup, Time Magazine has another five economists weigh in on the debt deal, including LU Econ Blog faves Alex Tabarrok and Simon Johnson.
It’s too bad we don’t have a macro course going on right now.
In today’s New York Times Economix column, former advisor to presidents Ronald Reagan and George H. W. Bush Bruce Bartlett argues persuasively that the debt ceiling and debate about it accomplishes nothing constructive that is not already contained in the Congressional Budget and Impoundment Control Act of 1974. Former Fed Chair Alan Greenspan made this point emphatically in his 2003 testimony to Congress.
In the Congress’s review of the mechanisms governing the budget process, you may want to reconsider whether the statutory limit on the public debt is a useful device. As a matter of arithmetic, the debt ceiling is either redundant or inconsistent with the paths of revenues and outlays you specify when you legislate a budget.
Current Fed Chair Bernanke put it even more starkly when he noted that the debt ceiling legislation is equivalent to using a credit card to buy things and then refusing to pay the bill when it arrives.
There has been much consternation these past few weeks about the federal budget and the debt ceiling, with the possibility that the ratings agencies could downgrade the U.S. credit rating. While some cheer the possibility of a U.S. default as a necessary step to reign in spending, MIT economist Simon Johnson writes that such a default would yield rather unhappy consequences.
A government default would destroy the credit system as we know it. The fundamental benchmark interest rates in modern financial markets are the so-called risk-free rates on government bonds. Removing this pillar of the system—or creating a high degree of risk around U.S. Treasurys—would disrupt many private contracts and all kinds of transactions.
The result would be capital flight—but to where? Many banks would have a similar problem: A collapse in U.S. Treasury prices (the counterpart of higher interest rates, as bond prices and interest rates move in opposite directions) would destroy their balance sheets. There is no company in the United States that would be unaffected by a government default—and no bank or other financial institution that could provide a secure haven for savings. There would be a massive run into cash, on an order not seen since the Great Depression, with long lines of people at ATMs and teller windows withdrawing as much as possible.
Yikes.
But that’s not all:
Private credit, moreover, would disappear from the U.S. economic system, confronting the Federal Reserve with an unpleasant choice. Either it could step in and provide an enormous amount of credit directly to households and firms (much like Gosbank, the Soviet Union’s central bank), or it could stand by idly while GDP fell 20 to 30 percent—the magnitude of decline that we have seen in modern economies when credit suddenly dries up.
With the private sector in free fall, consumption and investment would decline sharply. America’s ability to export would also be undermined, because foreign markets would likely be affected, and because, in any case, if export firms cannot get credit, they most likely cannot produce.
Not exactly a rosy picture.
Here’s brief background for those of you not steeped in AI or American game shows.
President Obama created a deficit reduction commission that has been asked to propose ways for the United States to bring down the (annual) deficit to GDP ratio from above 8% presently to 3% by 2015. The two committee chairs, Alan Simpson – former Republic Senator from Wyoming – and Erskine Bowles – former Clinton administration chief of state – have published a list of contentious ideas they believe necessary to achieve the intended target. They have not avoided controversial programs such as Social Security, Medicare, mortgage interest rate deductions, and defense spending since they recognize that serious plans require serious discussion.
Their report must be made public by December 1st, and if it garners the votes of 14 of the 18 commission members, it must face an up-down vote in each house of Congress. I find this effort the most interesting one related to politics since the Greenspan Commission to modify the Social Security program presented its report in 1983. I wish them good luck. They (and we) will need if we are to make serious progress and reducing future economic instability.
