A conflict between Republicans and Democrats over the debt limit ceiling can plunge the U.S. economy into a recession. Analysts warn that even if the standoff doesn't result in a debt default, the economic consequences could still be severe, with a more devastating recession and 7.5 million job losses if a default occurs.
Financial Markets Feel the Pinch
Treasury Secretary Janet Yellen's recent statement that the government may run out of money to pay its bills by early June is causing some areas of the U.S. debt market to feel the pressure. This situation affects payments to foreign and domestic investors in Treasuries, federal employees and contractors, and Social Security pensioners. The U.S. government spends approximately $525 billion a month, with around $225 billion being deficit spending in the first quarter.
Debt Ceiling's Impact on Americans
Reaching the debt ceiling would prevent the government from running a budget deficit, directly or indirectly affecting millions of Americans who rely on government funds. An unprecedented U.S. default could cause a market collapse and destroy billions in wealth. Analysts have suggested workarounds, but all are untested and may face legal challenges.
Investors React to Increased Risk
Following Yellen's announcement yields on $650 billion of Treasury securities maturing in the first half of June surged to record highs, reflecting the higher risk of delayed repayments. The cost to insure U.S. government debt against default has reached levels not seen since the 2007-2009 financial crisis.
Economic Outlook Worsens
The economic outlook is already dimming, with Nationwide Chief Economist Kathy Bostjancic predicting a recession later this year. The Federal Reserve's aggressive interest-rate hikes to combat inflation could increase borrowing costs for households and businesses, slow bank lending, and raise the unemployment rate to a historically low 3.5%.
Debt Crisis Impacts on GDP and Jobs
A debt crisis and default could exacerbate the recession and force the government to cut spending. This would impact individuals and businesses, directly affecting GDP and reinforcing the recession. The severity of the effects would depend on the duration of non-payments and the financial market's reaction.
Worst-Case Scenario: Prolonged Breach
A prolonged breach could turn a mild recession with 1-2 million job losses and a 5% unemployment rate peak into a more painful situation. In this worst-case scenario, unemployment could skyrocket to above 8%, resulting in 7.5-8 million job losses and a slow recovery. The U.S. credit standing could be permanently damaged, weakening the economy's long-term growth prospects.