Here’s what will happen to the economy as the debt ceiling drama escalates

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After the United States hit its debt ceiling on Thursday, the Treasury Department is now taking “extraordinary measures” to continue paying government bills.

Bankruptcy could be catastrophic, causing “irreparable damage to the U.S. economy, the livelihoods of all Americans and global financial stability,” Treasury Secretary Janet Yellen warned.

Yellen told CNN’s Christiane Amanpour on Friday that the impact will be felt by all Americans.

“If that happened, our borrowing costs would rise, and every American would see their borrowing costs rise as well,” Yellen said. “Furthermore, failure to make payments due, whether to bondholders, Social Security recipients or our military, would undoubtedly shrink the U.S. economy and could trigger a global financial crisis.”

She added: “It would certainly undermine the dollar’s role as a reserve currency used in transactions around the world. And Americans – lots and lots of people – would lose their jobs and their borrowing costs would certainly go up.

The dire warnings about the debt ceiling problem are nothing new. Federal lawmakers have already reached agreement in the past, and this Congress has time — at least until early June, according to Yellen’s public estimates — to agree on whether or not to raise the debt ceiling.

Many economists expect a deal to be reached. However, given the current “extremely turbulent political environment,” it could be a long process that would contribute to “spikes” in financial market volatility, Moody’s Investors Service said in a note Thursday.

Such volatility comes at a time when the Federal Reserve is trying to bring inflation down while navigating a soft (or soft) landing with minimal damage to the economy.

So what happens to the economy in the worst case of default?

It’s an understandable question with an unsatisfactory answer, said Michael Pugliese, vice president and economist of corporate and investment banking at Wells Fargo.

“The honest truth is nobody knows,” he said. “Widespread default by the U.S. government is not something we’ve ever experienced and haven’t even come close to.”

While a default is not something that can be modeled in the same way as a more historically common economic event such as a recession, the events of 2011 could provide an idea of ​​what would happen if the debt ceiling drama were turned into a debacle said Gregory Daco, chief economist at EY-Parthenon.

“2011 was the first time in a long time that we had almost breached the debt ceiling,” he said. “And it was a time when there was a lot of political fragmentation and a strong desire to basically tie austerity to any increase in the debt ceiling.”

The current environment includes similar austerity and desires to cut spending, he said.

But some fear this battle will be tougher than those in the past, a concern compounded by the fact that it took 15 votes to elect the Speaker of the House in what is normally the easiest vote for a new Congress. .

The economy of nearly 13 years ago was also different.

At the time, the Fed was in accommodative monetary policy mode and the economy in a weaker position as it was still recovering from the 2008 Great Recession, Pugliese said. Unemployment was north of 9% in July 2011.

That same year, the Treasury predicted that “Date X” — the date it would fail to pay its obligations on time — would fall on August 2, 2011. This was ultimately the date Congress passed and President Barack Obama signed into law. law that increases the limit.

The real economic impact of raising the debt ceiling in 2011 is difficult to isolate and quantify, Pugliese said, noting that the sluggish economic recovery in the US has also suffered from global events, including the global crisis. public debt in Europe.

Still, there were indications that the protracted congressional battle then contributed to an upheaval in the economy, he said. Real GDP growth was weak at -0.1% quarter on year on an annual basis in the third quarter of 2011. Financial markets were shaken, consumer confidence weakened, the index of political uncertainty The US economy reached a new high and Standard & Poor’s the rating agency downgraded the rating of the United States from AAA to AA+.

“I think you’d find it hard to say [the debt ceiling debacle] was a positive thing,” he said. “I see it more as one of many other hurdles to the economy, as it came from 9% unemployment at the time.”

This time, if Date X were to arrive without resolution, there is speculation that the Treasury could prioritize principal and interest payments to avoid a technical default, Pugliese said. There may be other “glass-breaking” options from the Treasury and Federal Reserve, but these are untested and short-term solutions, he added.

“Someone somewhere is going to get hurt if the government doesn’t have all of its money, whether it’s Social Security recipients, defense contractors, civil servants, veterans, [etc.],” he said.

The current economic climate is adding to the uncertainty, Daco said.

“We are entering this delicate period at a time when the US economy is clearly slowing and at a time when the global economic backdrop is also weakening…so the economic environment in which this debt ceiling is unfolding is that of a deeper economic slowdown. . .”

While a self-induced recession is likely after reaching an X date, turmoil could come sooner, Daco said.

“Financial markets and private sector players tend to react before that date,” he said. “If there is an expectation that we will be very close to that deadline, then financial market volatility generally increases and stock prices react negatively.”

A Treasury failure would undermine the global financial system, said Louise Sheiner, policy director at the Hutchins Center on Fiscal and Monetary Policy and a former senior economist at the Fed and the Council of Economic Advisers.

“If government bonds become something that people fear, it will ripple capital markets around the world in ways that are very difficult to predict,” she said.

Given the potential fallout in the United States and beyond, Sheiner believes the debt ceiling will eventually be lifted or suspended.

“There’s no other way around it,” she said. “It is impossible for Congress to cut spending by 20% in the middle of the year. That would push the economy into a recession. That would be terrible policy.

She added, “If you care about long-term debt, you actually have to change different laws, Social Security, health insurance, or tax laws… you want to do that in the process. appropriate, you want to do it well thought out. It is not something that should be done under duress.

CNN’s Maegan Vazquez, Matt Egan and Tami Luhby contributed to this report.

Not all news on the site reflects the site’s point of view, but we automatically transmit and translate this news through programmatic technology on the site and not from a human editor.

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