We’ve been hearing a lot about the debt ceiling recently, and yet I haven’t come across any news articles that really explain what the debt ceiling is. Perhaps this is because the debt ceiling is supposed to be self-explanatory, but I figure it’s better to be safe than sorry when it comes to educating. So I’ll start at the beginning.
Each year, the government can run either a deficit or a surplus. A deficit occurs when the government spends more than it takes in, and a surplus occurs when the government takes in more than it spends. If the government runs a deficit, it generally borrows in order to make up the difference. The government debt, on the other hand, is the accumulation of all of those deficits and surpluses- when a government runs a deficit, the debt level increases, and when the government runs a surplus, the debt level decreases. (Government surpluses are also sometimes referred to as public saving.) Easy, right?
People like to explain government spending by invoking an analogy to household spending, and I usually object to such analogies since there are important ways in which the government’s choices (and their consequences) differ from those of a household. In this case, however, the analogy works pretty well. As such, you can think of the debt ceiling as a government’s self-imposed credit limit. (Note later that Goolsbee says that it’s not like a credit limit because the government can agree to spend past the limit but then can’t pony up the cash when it comes time to spend. I equate this roughly with a situation where the credit card company lets you go over your credit limit but then charges you a fee and doesn’t let you do it again until you pay the balance down.) As with a credit card, when a government’s debt ceiling is reached, it can’t borrow any more money until it pays off some of its debt.
What does a household do when it maxes out its credit line and is still running a deficit? Well, it has a number of options: it could spend less, it could just not pay its bills on time, or it could declare bankruptcy. Clearly, the first of these options seems the most reasonable…but what happens when the household has consumption commitments such as a lease, car payments, etc.? Complete fiscal austerity is not usually an option for households, and it isn’t an option for the government either, since the government has committed to paying public employee salaries, making interest payments, honoring unemployment claims, and a whole host of other things. (This is the distinction between the discretionary and non-discretionary spending that you keep hearing about.) So what is a government to do?
This is where the debate about raising the debt ceiling comes in. Put simply, the government (in the longish term, at least) has the choice to either raise the debt ceiling or default on something. So what should it default on? If it defaults on its existing debt (i.e. doesn’t make interest payments), the government’s equivalent of a credit score will go down, and I don’t have to tell you what happens to people with bad credit scores. Well, maybe I do- they pay higher interest rates when they borrow in order to compensate for their riskiness. Therefore, defaulting on interest payments could make the situation worse, not better. So should the government just not pay people their salaries and unemployment instead? Let the mass rioting begin…
Austan Goolsbee, President Obama’s Chief Economic Adviser, explained most of this and more on the Daily Show. Granted, his preference for raising taxes as opposed to only cutting spending is very much a normative Democratic viewpoint as opposed to objective fact, but I very much appreciate that he tries to explain in reasonably normal-person terms what is going on. The video comes in three parts:
Now you know more than you probably ever wanted to about the debt ceiling. On the up side, at least you won’t be like the people who are somehow more worried about having debt than defaulting on said debt:
A new poll of terrified and economically illiterate Americans (“the public”) finds that more Americans are worried about our growing national debt than are worried about the prospect of defaulting on that debt, by failing to raise the nation’s debt ceiling. Americans! Always saying nonsensical things
In fact, fearing debt and fearing default are essentially the same fear: a fear of debt is simply a fear that we’ll be forced to default some time in the future.
It’s like if people said that they are afraid of the water rather than saying that they are afraid of drowning. Oh wait…