US President Joe Biden and House Speaker Kevin McCarthy struck a deal on the federal debt ceiling over the weekend that, if approved by Congress, will avert a disastrous debt default.
Less clear is what the agreement means for an economy that’s more or less shrugged off 5 percentage points’ worth of interest-rate hikes, or what it will do for government borrowing, which many analysts warn is on an unsustainable trajectory.
As spelled out in a 99-page document, the agreement would suspend the debt ceiling until Jan. 1, 2025, while capping discretionary spending for the next two years. The White House has said the deal will reduce outlays by about $1 trillion over a decade, while the Republican Party argues the cuts will amount to twice that.
Provided the agreement gets approved by Congress, it essentially kicks the fiscal can down the road.
Yet for all the weeks of Sturm und Drang, economists have been measured in their analysis of how the pact will affect the real economy or the Federal Reserve’s most aggressive monetary tightening since the 1980s.
Most economists expect the US will tip into a recession over the coming year: Those surveyed by Bloomberg before the debt deal was reached had penciled in a 0.5% annualized drop in gross domestic product for both the third and fourth quarters. Measures in the agreement, such as clawbacks of Covid-19 assistance or the phaseout of forbearance on student debt, could crimp consumer confidence, affecting both the timing and the severity of a downturn.
Textbooks also say that tightening fiscal and monetary policy at the same time heightens the risk of a recession—though it’s worth noting that the bounce-back from the Covid slump has been no ordinary recovery.
While Republicans have billed the agreement as the biggest deficit-reducing legislation in a dozen years, the general consensus among analysts is that it doesn’t quite live up to the hype. “In reality it’s a modest proposal with plenty of workarounds and budget gimmicks,” says Ben Koltun, director of research at Beacon Policy Advisors.
Similarly, Goldman Sachs Group Inc. called the deal a “major reduction in uncertainty, minor reduction in spending.” Goldman’s chief political economist, Alec Phillips, described its effects on growth as “very modest” in a note to clients.
Others have a similar take. Michael Feroli, chief US economist at JPMorgan Chase & Co., wrote in a note to clients that “the implied spending reduction doesn’t look like a game-changer for the macro outlook.”
Evercore ISI’s senior US policy and politics strategist, Tobin Marcus, also noted that the impact is likely to be modest, but added a line of caution.
“Nailing all this down based on public information is incredibly difficult because the whole thing relies on some handshake agreements on side deals between Biden and McCarthy,” Marcus wrote in a note.
Several observers have highlighted that the fiscal tweaks don’t kick in until the 2024 fiscal year, which starts in October, meaning the impact on various parts of the budget could be anywhere from 4 to 16 months out. “That’s an eternity in our business, and who knows what else will hurt or boost the economy over that time frame,” says Stephen Stanley, chief US economist at Santander US Capital Markets LLC.
The peak impact will come later next year by lowering real GDP by 0.15%, cutting 150,000 jobs and increasing unemployment by about 0.1 percentage points, according to Mark Zandi, chief economist at Moody’s Analytics. “Not desirable given the uncomfortably high recession risks, but manageable,” he says.
All of which raises doubts about how the agreement affects borrowing.
Before the deal was reached, Bloomberg Economics had calculated that US gross general government debt is on a path to reach 145% of GDP by 2028, up from 122% in 2022.
The International Monetary Fund said on May 26 that the government will need to rein in the deficit through options that include higher taxation, cutting health-care costs and closing tax loopholes, policy choices that the fund acknowledges would be politically difficult to pull off.
Analysis by Oxford Economics shows US debt-servicing costs have surged in line with rising interest rates. The interest payment due to investors this year, excluding government programs such as the Fed’s massive bond-buying program, are set to rise by $374 billion—or a 40% year-on-year increase.
For all the theatrics, the debt-limit agreement won’t do much to change that outlook, says Santander’s Stanley.
“I have been sounding the alarm for a while that the federal government is on an unsustainable deficit trajectory,” he says. “This deal is a baby step in the right direction, but I fear that the changes agreed upon were too small to get the budget picture back on track.”
--With assistance from Christopher Condon and Viktoria Dendrinou.
©2023 Bloomberg L.P.
