The behavioral case for the debt ceiling

By Felix Salmon
January 12, 2011
John Carney takes a stab at answering my question about why we have a debt ceiling, saying that it "helps raise public awareness about the costs of government":

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John Carney takes a stab at answering my question about why we have a debt ceiling, saying that it “helps raise public awareness about the costs of government”:

Lawmakers must go on record as approving an increase in the debt limit in order to enable the government to borrow to fund the spending the lawmakers have approved. They must confront, in a very public manner, the costs of the programs they have enacted.

I’m not at all sure this is the actual reason why we have a debt ceiling; at best it’s a behavioral reason not to abolish it. But it’s not a good reason.

Let’s take a personal-finance analogy here. A credit card company comes along and offers you a card with a $200,000 credit limit—much more than you should ever borrow. But you know that if the money is there for the spending, you’ll be more likely to spend it. So you phone up the credit card company and do a deal with them. You set the limit very low—$1,000, say—and then, any time you want to go over that limit, you have to phone up the credit card company and get them to raise it.

You know in advance that the credit card company will say yes: after all, they’ve already told you that as far as they’re concerned they’re happy to lend you $200,000. But being forced to phone them up and ask for a credit-line increase helps to drive home the consequences of your spending decisions, in a way that simply whipping your card out at the Apple Store doesn’t.

So far so good. But what if you were using your card not only to buy iPads, but also to make rent? And what if there were possible glitches with the system whereby you phoned up and asked for a credit-limit increase, so that you couldn’t be sure it would always work? And what if a single late rent payment could be catastrophic, ending up with you thrown out of your home? At that point, your clever system would stop seeming so clever, and start seeming downright risky.

And that’s the problem with the debt ceiling. It might have interesting and possibly even beneficial behavioral second-order effects, although there’s precious little evidence for that. But getting those beneficial effects means playing with fiscal high explosives, which run the risk of blowing up in the economy’s face and causing major damage. It simply isn’t worth it.

17 comments

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Alea has a link to a good document on the history of the debt limit:

http://www.aleablog.com/the-us-debt-limi t-history/

But I do not think your personal finance analogy holds. The point of Carney’s argument is “Lawmakers must go on record“. So in addition to passing a budget full of flowers for children and free ponies for everybody — easy to confuse people with — lawmakers must also vote specifically to raise the limit on the nation’s total debt.

I do not see this as a bad thing. It makes our legislators more accountable, specifically by making their hypocrisy more obvious, which is always good.

Incidentally, Sen. Obama voted against raising the debt ceiling in 2006. Just an aside.

Posted by NemoP | Report as abusive

You think Congress will accidentally forget to raise the debt ceiling? Or that anybody is seriously worried about the possibility?

If they wanted to force a default, I imagine they could vote on that as well. Similarly unlikely. The only difference I see is that the debt ceiling requires that they actually enact legislation — beating any filibusters. So I guess if just 40% of the Senate were to favor default, they could force the issue?

Posted by TFF | Report as abusive

Felix,

Great analogy assuming the credit card owner is the monopoly issuer of the currency the credit card debt is in.

The debt ceiling is just a parlor trick.

We don’t “borrow” money from any country. We set our own interest rates. And we could make it zero if we wanted.

The whole idea that the US govt could default is beyond absurd.

I love most of your reporting but this reads like another Peter Peterson press release.

Posted by petertemplar | Report as abusive

“We don’t “borrow” money from any country. We set our own interest rates. And we could make it zero if we wanted.”

Please explain, petertemplar? Treasury bonds are sold at auction. The interest rates are set by the buyers in the auction. (The coupon is estimated ahead of the auction in an attempt to keep the sale price from diverging too far from the par. But that is still buyer-driven.)

Are you advancing a different line of reasoning?

Posted by TFF | Report as abusive

I don’t understand why there’s a view that the government would default. The more likely scenario would seem to be that the government would delay/cancel payments unrelated to debt service, e.g. stop sending out social security checks. Or not pay out tax refunds. Or are these payments required by law to be made before debt service?

Posted by cparham | Report as abusive

The debt ceiling is a bargaining tool and I expect it will lead the way to important spending cuts in years to come.

“You want to increase the debt ceiling? You have to cut the structural deficit 10% (or better 30%), and you have a deal.”

The analogy of getting thrown out of your house is a poor one. Felix, you are confusing a second derivative with a first derivative. (Main variable = budget, first order derivative = spending, 2nd order derivative = change in spending). Spending remains very positive. The change in spending goes negative, but that isn’t the end of the end of the world.

If your credit line is not increased but you still have your job (analogous to tax revenues still coming in) your spending will have to curbed or you will have to earn more but it is not the end of the world. Would this be contractionary? Perhaps, but so was Volcker’s action in the early 1980s. America did not end up on the street. Quite the contrary.

Posted by DanHess | Report as abusive

I suspect that a balanced budget, although it would slam our economy in one sense (government spending would decline), would give America a huge positive demand shock that would represent a sharp offsettting boost. Why?

Those overseas and local dollars which are presently pouring into treasury debt would go into American goods and services, as well as raise demand for assets. Jobs would get a big boost from this.

Posted by DanHess | Report as abusive

And more… US interest rates would drop on mortgages and many other things if Treasury supply dried up.

Posted by DanHess | Report as abusive

And yet more, the great fear in this country and especially among those with the means to spend is America’s fiscal trajectory. Work on that and American confidence will return!

Posted by DanHess | Report as abusive

Dan Hess, you are the poster boy for upper class idiocy.

The reason why Americans lack confidence is that 18% of Americans have lost their livelihood. A budget balanced via spending cuts would quickly raise that to 25% and give us a genuine, sparkly Great Depression II.

I know that’s exciting if you have 5000 friends, a large arsenal and a defensible hilltop in Montana with a good water supply.

But the rest of us think it’s pretty sensible to balance the budget by, you know, funding the government the way we did when our budget was balanced – cutting defense spending and requiring the very, very wealthy to pay 40% of their gained income, and 28% of their capital gains, in taxes.

And then we think the path to long term prosperity is to invest in strengthening our education system and at least slow down the outsourcing our jobs to Asia. And many of us think that it would be a good idea to spend less than $500B per year on foreign energy supplies, perhaps through some reasonable conservation and alternate energy measures, and ending $30B in annual subsidies to foreign multinationals in the oil business.

But then why do what’s proven to work? Dan Hess thinks he deserves a tax break!

Posted by Dollared | Report as abusive

Dollared, when was it proven to work?

Posted by Danny_Black | Report as abusive

You want “proven to work”? Let’s spend $58M to create 800 jobs for two years.

http://www.boston.com/business/articles/ 2011/01/12/evergreen_solar_to_cut_800_jo bs_as_it_tries_to_compete_with_china/

Unfortunately that is pretty typical of governmental efficiency.

Wealth is generated when people work at a useful job. The government can and does redistribute wealth, in the interests of social equity, but it is not very good at creating wealth. Moreover, governmental actions tend to distort the economy in ways that reduce wealth production.

A fine balance to maintain, perhaps, but I don’t think balancing the budget would devastate the economy. At worst it would weaken the safety net.

Posted by TFF | Report as abusive

Let’s not simplify the math by taking dollars spent (or tax breaks provided) and dividing by jobs. I got the sense that this was intended as an investment (a failed one) as opposed to a primary jobs creation piece.

There was infrastructure development as well, although the article does criticize that decision too.

Posted by djiddish98 | Report as abusive

You may be right (I don’t think so, but I’m willing to entertain the notion), but your analogy is very flawed. Several years ago my bank gave me an AmEx with a $100K credit limit, and even paid the exhorbitant annual fee. It changed my spending habits not one iota.

Besides, I’m pretty sure that when Congress passes an increase to the debt ceiling, its members don’t silently think “Great, that’s $500 billion more I can spend in arrears without anyone asking any questions.” I tend to the notion that a debt ceiling gives us a reason for some soul-searching.

Posted by Curmudgeon | Report as abusive

@Dollared –

“Dan Hess, you are the poster boy for upper class idiocy.”

Har har, don’t I wish! I actually am a middle class public servant. So a balanced budget would roast my hide forthwith! But I also have children and therefore want to see America remain great.

I think comparisons with the Great Depression are very important to make. In many ways our situation is almost totally the reverse of what it was in the lead-in to the Great D. Then, we were had an enormous balance of payments surplus, and we were the great exporter to the world. We sat on a huge pile of reserves. As world trade slowed, we went through the greatest negative balance-of-payments shock history had ever seen. Meanwhile, debtor nations cruised on through, seeing little negative demand shock and sometimes even a boost.

Conversely, the nation that is the position of the US ahead of the Great D is not the US of 2011 but rather China of 2011. In a mercantilist system where they buy our bonds and sell us goods, they get the jobs. If we want the jobs, we have to break this cycle by balancing our budget.

Posted by DanHess | Report as abusive

DanHess, you are neglecting a key comparison from the 1930s. Germany was buried under debt (largely reparations from the Great World War). A round of deflationary budget cuts fed a decline in the GNP of 25% over a span of three years. Liquidation/nationalization of half the big banks in the country. Monetary easing. So many parallels, ESPECIALLY if you see Fannie/Freddie as massive banks.

In Germany, that set the stage for rising nationalism, blaming of the crisis on a significant minority underclass, and ultimately the rise of the Nazi Party. You can see these same forces at play in the US today, though the names and ethnic groups involved are a little different.

There ARE differences. We aren’t tied to a gold standard (thus massive monetary easing is very simple). Our debts are denominated in our own currency. We responded to the initial crisis with fiscal stimulus, rather than budget cuts that deepened the crisis. I’m sure the smart people here can come up with other key differences that I’ve missed.

Still, the similarities are chilling. Hopefully we find a better solution than Germany did?

Posted by TFF | Report as abusive

@TFF, thanks for pointing that out!

I think the Fed’s ability and awareness to fight deflation makes all the difference in the world.

In massive deflation asset prices collapse as they are sold at inappropriate fire-sale prices to raise emergency funds. Economics essentially breaks down and great businesses are destroyed as the line between illiquid and insolvent vanishes.

To me it is perfectly reasonable to be fiscally tight and monetarily loose, but that is by no means my original idea. That is the old and standard IMF solution, completed successfully in countless countries around the world. IMF or not, that seems a standard path in the end. Most recently that was the basic path in places like Argentina and Iceland, which have gone from total failure to stability, growth and jobs.

In fact fiscal tightness and monetary looseness is such a normal endgame that the only question may be when it happens and how many years and how much growth are lost in the interlude.

Posted by DanHess | Report as abusive