The recent debt deal struck by President Joe Biden and House Speaker Kevin McCarthy has ignited a delicate balance between ensuring economic stability and mitigating the risks of a looming recession.
Assuming its passage by Congress, the agreement aims to avert a catastrophic scenario of a payment default triggering a financial collapse. However, the implications of this debt deal extend beyond avoiding immediate disaster, as it introduces additional complexities and potential headwinds for the world’s largest economy.
The deal, if passed by Congress, suspends the debt ceiling until January 1, 2025, delaying another fight over federal borrowing authority until mid-2025.
However, the deal could add to the risks of a downturn in the US economy, albeit marginally.
Federal spending has supported US growth in recent quarters, but the debt-limit deal will likely dampen that impetus.
Economists had previously calculated a 65% chance of a recession in the coming year, highlighting the existing risks. The spending cap in the deal will impact the Federal Reserve’s projections for growth and the benchmark interest rate.
Highlights of the Debt Deal
The deal combines restrictive fiscal policy with a tightening monetary policy, potentially amplifying the economic effects.
Stock futures have advanced, and Treasury futures indicate a slight decrease in implied yield.
The spending limits are expected to be applied from the fiscal year beginning October 1, with potential small effects emerging earlier.
The degree to which the spending limits are effective or mere “gimmickry” remains a topic of consideration.
How It Affects the Economy
The deal’s fiscal restraint could have a larger impact on GDP and employment in the event of a downturn.
The combination of fiscal and monetary policy may help quell inflation if the economy slows down.
1. Unemployment
Despite recent Fed rate hikes, the US economy has remained resilient, with low unemployment and excess savings from the pandemic.
Amidst the current economic landscape, one significant aspect that stands out is the record-low unemployment rate. At a staggering 3.4%, the US job market has witnessed historically high worker demand, reflecting a resilient economy. However, economists express concerns about potential shifts in this trend. With the debt deal’s fiscal restraint potentially impacting spending levels, there is apprehension that a slowdown in the economy could result in higher unemployment rates.
Fiscal multipliers, which tend to have a more significant impact during a recession, could exacerbate the effects of reduced fiscal spending on GDP and employment. As policymakers grapple with striking a delicate balance between stability and growth, unemployment remains a crucial factor to monitor.
2. Treasury bill
As part of the debt deal, the US Treasury is set to ramp up sales of Treasury bills to rebuild its cash balance. This move aims to replenish the depleted stockpile resulting from the prolonged suspension of the debt ceiling. However, the influx of newly issued Treasury bills is expected to affect money markets and liquidity.
3. Non-Significant effects
The longer-term fiscal restraint in the deal is unlikely to address the trajectory of federal debt significantly.
The International Monetary Fund suggests tightening the primary budget by 5% of GDP to reduce public debt by the decade’s end.
The spending caps in the deal are subjective and may pose minimal fiscal headwinds while marginally reducing deficits.
The deal avoids a payments default and temporarily resolves the debt ceiling issue but it could contribute to economic risks. Fiscal and monetary policies will influence growth, inflation, and employment. The deal’s spending limits, effectiveness, and impact on the trajectory of federal debt are subjects of ongoing analysis and debate.
