09/10/2013 - The current political deadlock in the United States is needlessly putting at risk the stability and growth not only of the U.S. but also the world economy. This comes at a time when a fragile recovery in advanced economies was underway, and when a number of emerging economies were already facing new risks. We still see the probability of failing to raise the debt ceiling as low, but as the government shutdown drags on, the level of concern is ratcheting up. If the debt ceiling is not raised -- or, better still, abolished -- our calculations suggest that the OECD region as a whole will be pushed back into recession next year, and emerging economies will experience a sharp slowdown. The magnitude of further possible negative feedback effects can only be guessed at.
In the U.S., the sequester has already resulted in a large and arbitrary fiscal consolidation, and this is now being compounded by the shutdown. But the consequences of failing to raise the debt ceiling would be much worse. Government consumption would have to shrink immediately by at least 4 percentage points of GDP, subtracting a similar amount from GDP growth in 2014. A default on government debt would result in an even more serious outcome. Even if the likelihood of this is low, just the uncertainty about the government’s ability to avoid a default on part of its debt would result in disruptions in financial markets that would deepen the economic downturn, lowering tax revenues and forcing more cuts in public spending. We would also expect to see serious stresses in the banking system at a time when the federal government would not be able to offer emergency assistance. Unemployment would rise back to levels seen in the wake of the financial crisis.
Other countries would also be severely affected. The U.S. would reduce its imports from the rest of the world, and higher U.S. bond yields and lower asset prices would feed through to other markets, tightening financial conditions. Confidence would take a sharp hit virtually everywhere. Moreover, putting the world’s primary risk-free asset into doubt would have negative repercussions throughout the global financial system. These effects would of course feed back on the U.S. economy.
We trust in the wisdom of U.S. political leaders to raise the debt ceiling and ensure the normal operation of the U.S. government.