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Towards the Next Default Threat?

This week The New School’s Schwartz Center for Economic Policy Analysis (SCEPA) hosted three New School economists to discuss the economic and political fallout of the government shut down and the possibility of a default. Professors Teresa Ghilarducci, Rick McGahey and Christian Proaño discussed possible scenarios in case the United States would default on its debt, and the political economy of both the shutdown and the debt ceiling crisis.

Christian Proaño, a former economic forecaster, explained two possible reactions by the financial markets in case it would come to a default: A: the not so good scenario; and B: the really bad scenario. As a side bar, just a day earlier the Swedish Academy awarded its Nobel Memorial Prize in Economic Science to two American economists with opposing views about the rationality of financial markets, forcing both economists and the world to wonder if the workings of financial markets are ever clear. Under Proaño’s first scenario the reactions by the financial markets are not strong; markets will not lose their trust, banks will keep on lending to each other, there will not be a credit crunch and the the dollar will remain stable. But still, as Social Security payments will come to a halt before the end of this month, especially people with low incomes will be affected.

The second scenario is more disastrous. A stronger reaction by the financial markets will drive interbank lending towards a collapse, in which, as in 2008, households and firms will be drawn into a slump that can extend worldwide. This would be IMF’s Christine Lagarde’s warning that U.S. Congress risks pushing the world into a recession, as Teresa Ghilarducci emphasized, “a chilling assessment by one of the world’s leading economists.”

Even now all parties, i.e. the House, the Senate, and the White House have reluctantly come to a last minute agreement, the deal is a temporary one. Rick McGahey mentioned, “This is the fifth shutdown or default threat since March 2011.” As the former Executive Director of the Joint Economic Committee of Congress in the 1990s, he seems to be familiar with painful experiences. Because of the unique way the American political system is set up, in which the President is forced to go to Congress to raise the debt ceiling, the debt limit has become a powerful lever in ideological fights between Democrats, Republicans and nowadays, the members of the Tea Party within the Republican Party.

So far, the latest tactics of fear and threats by Republicans, driven by their dream to shrink government, have paid off. And as long as the Republican Party, also helped by the redrawing of Congressional districts, rules the House, a different scenario is not in sight. Still, we wonder “Will there be a political fallout from these dangerous political games, or do we have to wait until 2020 when the next census drawing will take place?” And, “are there any economic and financial solutions to prevent or better anticipate negative economic consequences of both a government shutdown and, more dangerously, the US defaulting on its debt?” Let’s continue the discussion. —Esther Kreider-Verhalle

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Esther Kreider-Verhalle

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