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If debt ceiling talks yield no deal, how bad for US economy?

Higher interest rates. No money for things like highways, federal workers, defense contractors, food stamps. Return to recession. That's what most economists see as inevitable if national debt ceiling is not raised.

By Staff writer / July 15, 2011

The Capitol is seen in Washington, Thursday, July 14, as Congress and the Obama Administration continued to work to raise the debt ceiling.

Alex Brandon/AP


If Democrats and Republicans don't agree to raise the national debt ceiling by Aug. 2, economists say the consequences would be swift and severe.

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The US economy could plunge into a new recession as the massive daily spending of the federal government grinds to a partial halt. The stock and bond markets would be sent reeling. Interest rates would jump upward, not just for US Treasury bonds but also for other debts such as mortgages and auto loans.

The financial fallout would not be limited to the United States. Even if the "no-deal" period during August were brief, it could have long-lasting negative effects on investor confidence in America's creditworthiness.

All that sounds like an armageddon scenario. But those assessments are widely held by mainstream economists who don't have a partisan stake in the debt talks. They're not saying the world would actually end, but they are warning Washington that jobs and livelihoods – not just political wins and losses – are at stake.

"Failure to raise the U.S. federal debt ceiling ... would lead to a massive fiscal contraction and a financial crisis, although it would not necessarily mean a debt default," economist Nigel Gault concludes in an analysis for IHS Global Insight, a forecasting and consulting firm in Lexington, Mass. "The spending contraction, if sustained, would send the economy back into recession."

Mr. Gault explains the problem this way. Currently, federal revenues fall far short of spending. If Congress doesn't give the Treasury authority to borrow, beyond its current $14.3 trillion limit, there would be an immediate cut of 40 to 45 percent in government spending.

That cutback would equal about $1.5 trillion at an annual rate, or 10 percent of America's gross domestic product. So a recession, or decline in GDP, is not far-fetched if such an impasse were to persist.

Having no deal in place "would no doubt have a very adverse effect very quickly on the recovery. I'm quite certain of that," Federal Reserve Chairman Ben Bernanke said recently.

Meanwhile, debt-rating agencies have warned that America's credit score is already coming under scrutiny.

"Interest rates would be expected to rise – but by how much is far from clear," Mr. Gault said in his assessment.

In a no-deal scenario, the government would have incoming tax revenue that far exceeds the interest payments due (about $30 billion per month) on outstanding debt. So, in theory, the Treasury could try to prioritize payments so that credit markets are reassured that bond interest payments are not at risk.


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