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What Is Next for the U.S. Economy, Post-Debt Ceiling Debate?

The drama surrounding the debt ceiling is over for now.  It went down to the wire, but a package was signed by the president that has allowed the U.S. government to avoid defaulting on any of its obligations.  The next question is: What will be the impact of this crisis on the economy, writ-large? 

The end of the crisis is a good thing for the U.S. economy.  The nation’s output increased at an annual rate of just 0.8 percent in the first half of this year, the weakest two-quarter growth rate since the recession ended two years ago. Many factors have been holding back the recovery, but the uncertainty stirred up by the debt ceiling battle looks to have exacerbated the problems. Consumer confidence has slipped substantially since the beginning of the year, a decline that no doubt contributed to the weakness we saw in today’s report on monthly consumer spending. Likewise, businesses appear to have been extremely cautious about hiring of late, as evidenced by the paltry growth in private employment in May and June. Animal spirits should rise on having averted the potential default, which, in turn, should put the economic recovery on firmer footing.

It remains unclear whether the credit ratings agencies will downgrade U.S. Treasury debt, as they have threatened to do. They may defer the decision until later this year to see if Congress is able to pass a second round of budget cuts that a bipartisan commission of lawmakers has been tasked with finding. Those savings would not large enough to deliver a stable debt-to-GDP ratio (nor would the automatic measures triggered by a failure to pass these cuts), but they would represent significant progress toward that goal. 

Even without a downgrade, the turmoil over the debt ceiling is likely to take a long-term toll on economic growth. The episode has vividly illustrated just how far apart views are on how we should deal with the unsustainable long-term path of the federal budget. It also has demonstrated just how unwilling the different sides are to compromise. Going forward, it seems hard to believe that investors will see U.S. Treasury securities as quite as “risk-free” as they did earlier. Thus, Treasury interest rates are probably going to be higher than they would be if Congress had raised the debt ceiling when the issue first arose, and, with private interest rates tending to follow government rates, financial conditions should be tighter and economic growth lower.

A broader point is that the federal debt situation is only one of the structural problems weighing on our economy. Economic growth is also being held back by a still-significant household debt overhang, lingering fragility in our financial system, and the need for reforms to our education, immigration and regulatory policies. If the United States is to remain a leading world economy, political leaders need to work together and address all of these challenges.

  • Karen Dynan is no longer affiliated with the Brookings Institution. She was the vice president and co-director of the Economic Studies program at the Brookings Institution from 2009 to 2013. She now serves as Assistant Treasury Secretary for Economic Policy.