Debt Limit Policy Questions: What Are the Potential Economic Effects of a Binding Federal Debt Limit?

May 25, 2023 R47574

Debt Limit Policy Questions: What Are the
May 25, 2023
Potential Economic Effects of a Binding Federal Brendan McDermott
Debt Limit?
Analyst in Public Finance

Federal law prohibits the “face amount of obligations whose principal and interest are guaranteed
Grant A. Driessen
by the United States Government” from exceeding the statutory debt limit (31 U.S.C. §3101).
Specialist in Public Finance
The Department of the Treasury has the power to take some temporary “extraordinary measures”

that extend the date on which the statutory limit is reached. In the event that the federal
government reaches the statutory debt limit and exhausts extraordinary measures, the law

prohibits Treasury from incurring any additional debt, and Treasury would be required to meet
spending demands exclusively through money received from incoming revenues and existing debt.
How Treasury would respond under such a scenario is unclear. Among its options would be delaying payments until it is able
to make them in full or making partial payments on time. Some have proposed that Treasury prioritize certain payments over
others, though it is unclear whether Treasury has the capability to construct its payment systems to accommodate payment
prioritization or if it has the legal authority to pursue that strategy under current law. The practical hurdles may be less
significant for principal and interest payments on the national debt, which the government makes through a separate system
managed by the Federal Reserve. Lawmakers have introduced legislation that would direct Treasury to prioritize certain
payments in the event of a binding debt limit.
Financial institutions around the world perceive U.S. Treasury securities to be among the safest assets available. If investors
became concerned that Treasury could not make timely and full payments on the federal debt—regardless of whether the
United States actually defaults on debt payments—they will demand higher interest rates. An increase in interest costs would
increase future government outlays and therefore cause the national debt to grow more quickly than it otherwise would.
Making partial or late payments on the national debt might also harm economic activity and the global financial system.
Many financial institutions hold large amounts of Treasury securities to use as collateral in large transactions, making the
perceived safety of those securities fundamental to the functioning of global financial markets and trade. A sudden perception
that U.S. Treasury bonds are riskier would make these bonds less valuable, threatening the systems the bonds underpin. A
decline in the value of federal bonds would also lead to a loss of wealth for the businesses, households, and foreign entities
that hold these bonds. This decline could have unpredictable effects on the domestic and global economy.
Cuts to other federal spending might also threaten economic demand in the United States, which may reduce economic
activity and increase both the likelihood and magnitude of a recession. The exact scale of this decline would depend on which
payments the federal government does not make in full and on time; the duration of the debt limit episode; and the state of
the economy and financial system at the time of the missed payments. A binding debt limit would also prevent the federal
government from financing stimulus outlays or automatic stabilizers with new debt, leaving fiscal policy less capable of
addressing an economic downturn.
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link to page 6 The Potential Economic Effects of a Binding Federal Debt Limit

The Debt Limit
Under current law, the federal government’s outlays are projected to exceed its revenues both this
year and in the foreseeable future, according to the Congressional Budget Office (CBO). As a
result, the federal government must finance its spending by borrowing money, which it does
through debt issuances of Treasury securities, including Treasury notes, bills, and bonds
(collectively known as “Treasuries”). The amount of money that the Department of the Treasury
may borrow is restricted by a statutory limit on the debt, referred to as the debt limit or debt
ceiling (codified at 31 U.S.C. §3101).
The statutory debt limit is currently just under $31.4 trillion. On January 19, 2023, Treasury
Secretary Janet Yellen began implementing “extraordinary measures” to prevent the debt limit
from binding and allow the government to make its payments in full and on time.1 Subsequent
estimates from the CBO and private sources project that extraordinary measures will be
exhausted in June.2 Such estimates are subject to considerable uncertainty.
Effects on Spending of a Binding Debt Limit
In the event that the debt limit binds, Treasury could not legally borrow any new debt; it could
only roll over existing debt. Treasury would then have several options available to finance outlays
as they exceed amounts provided from incoming revenues.3 First, Treasury might make partial
payments on behalf of the federal government at the time those payments are due. Second, it
might delay payment until Treasury had enough cash and deposits to make the payment in full.
Some have suggested a third option; namely, that Treasury prioritize certain payments over
others, although this raises practical and legal considerations (see “Prioritization” below). One
outside analysis suggests that, if Treasury prioritized interest payments with a binding debt limit,
noninterest outlays would immediately fall by roughly 25%.4
The scale of cuts or delays in payments necessary would depend on several factors. Longer debt
limit episodes would require greater cuts or delays. Treasury would have to make larger changes
in periods when net deficits (the amount by which outlays exceed receipts) are higher and smaller
changes in periods when net deficits are lower. Receipts are typically highest in April, when
individual income tax filings are due, and in September, when the government tends to receive
income tax payments from filers who requested extensions. Similarly, outlays are typically
highest when payments on certain broad benefits such as Social Security are due, as well as days
on which the federal government pays its employees.

1 Letter from Janet Yellen, Secretary of the Treasury, to Hon. Kevin McCarthy, Speaker of the House of
Representatives, January 13, 2023, at https://home.treasury.gov/system/files/136/Debt-Limit-Letter-to-Congress-
McCarthy-20230113.pdf. For more on extraordinary measures, see CRS Insight IN10837, Debt Limit Policy Questions:
What Are Extraordinary Measures?, by Grant A. Driessen.
2 U.S. Treasury, “May 1, 2023 Letter to Congress,” May 1, 2023, at https://home.treasury.gov/system/files/136/
Debt_Limit_Letter_Congress_Members_05012023.pdf.
3 Letter from Eric M. Thorson, Chair, Council of the Inspectors General on Financial Oversight, to Hon. Orrin G.
Hatch, Ranking Member, Committee on Finance, August 24, 2012, Enclosure 1, pp. 3-6, at https://oig.treasury.gov/
sites/oig/files/Audit_Reports_and_Testimonies/OIG-CA-12-006.pdf.
4 Wendy Edelberg and Louise Sheiner, “How Worried Should We Be If the Debt Ceiling Isn’t Lifted?” Brookings
Institution, April 24, 2023, at https://www.brookings.edu/2023/04/24/how-worried-should-we-be-if-the-debt-ceiling-
isnt-lifted/.
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link to page 5 The Potential Economic Effects of a Binding Federal Debt Limit

Table 1. Federal Outlays, Receipts, and Deficits, April 2022-March 2023
(in billions of nominal dollars)
Deficit (-) or Surplus
Month
Outlays
Receipts
(+)
April 2022
555
864
308
May 2022
455
389
-66
June 2022
550
461
-89
July 2022
480
269
-211
August 2022
523
304
-220
September 2022
917
488
-430
October 2022
406
319
-88
November 2022
501
252
-249
December 2022
540
455
-85
January 2023
486
447
-39
February 2023
525
262
-262
March 2023
691
313
-378
Source: U.S. Treasury, April 2023 Monthly Treasury Statement, at https://www.fiscal.treasury.gov/files/reports-
statements/mts/mts0323.pdf.
Note: All figures rounded to the nearest bil ion.
Table 1 shows monthly federal receipts, outlays, and net deficit totals from April 2022 through
March 2023. Sources of fluctuation include the timing of federal income tax payments and other
revenues, seasonal patterns in outlays, and the enactment of new legislation and policies
(including the cancellation of some federal student debt in late August 2022).5
The federal government has never operated under a binding debt limit. Economic theory and
available evidence from past incidences with anticipated binding debt limits indicate that the
effects of a binding debt limit could include
• the direct effect of late or missed federal payments;
• financial market effects, both from federal security investors and in market
transactions where federal securities play a prominent role; and
• indirect effects on borrowing and general economic confidence from households,
businesses, and other governments.
The relative prominence of the federal government both in financial markets (38% of all 2021
U.S. fixed income issuances were U.S. Treasury securities)6 and in general economic activity
(federal spending is projected to equal 24% of U.S. GDP in FY2023)7 suggests that even a brief
breach of the debt limit might have significant effects on financial and economic performance.

5 Biden Administration, “Fact Sheet: President Biden Announces Student Loan Relief to Borrowers Who Need It
Most,” August 25, 2022, at https://www.whitehouse.gov/briefing-room/statements-releases/2022/08/24/fact-sheet-
president-biden-announces-student-loan-relief-for-borrowers-who-need-it-most/.
6 Securities Industry and Financial Markets Association, “Capital Markets Fact Book, 2022,” July 2022, at
https://www.sifma.org/resources/research/fact-book/.
7 Congressional Budget Office, The Budget and Economic Outlook: 2023 to 2033, February 2023, at
https://www.cbo.gov/publication/58946.
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The Potential Economic Effects of a Binding Federal Debt Limit

Prioritization
Some have suggested that Treasury could “prioritize” some payments over others. For example,
Treasury could make payments on the national debt and/or to Social Security beneficiaries in full
and on time, while making partial or delayed payments on other programs. At the height of the
debt limit episode in August 2011, information from the Federal Reserve suggests that
discussions occurred on the prioritization of payments—indicating that there may have been plans
regarding a prioritization of payments on Treasury security principal and interest had the debt
limit bound at that time.8
Prioritization faces both practical and legal challenges. Treasury has said it is unsure whether it
has the technical capacity to prioritize certain types of payments over others. Generally, Treasury
designed its systems to make payments automatically as they come due.9 Payments on the
national debt may be more feasible to prioritize than other payments, as the Federal Reserve pays
these through a separate system, although Treasury expressed that doing so “would be entirely
experimental and create unacceptable risks to both domestic and global financial markets.”10
Even if prioritization is practically feasible, it is not clear whether Treasury has the legal authority
to pursue it.11 The executive branch is generally required to make payments in accordance with
laws as enacted, and these laws did not expressly address prioritization. As such, it is unclear
whether the executive branch has the legal authority to prioritize payments under current law.
Legislation has been introduced in the 118th Congress to prioritize certain payments.12
Potential Economic Effects of a Default
on Treasuries
Perception of Risk
A debt limit episode’s effect on financial markets and the broader economy would depend on
whether investors perceived Treasuries as having become riskier. Though investors perceive the
federal government as among the safest of major borrowing institutions,13 expected or actual late
or missed federal payments may risk causing a downgrade in that perception and increase the
interest costs the government faces on its future debt issuances. Investors would likely demand
higher interest rates to hold Treasuries that they think have a greater likelihood of defaulting.
Past debt limit episodes suggest that investors may perceive Treasuries as riskier even if they only
anticipate the debt limit will become binding, regardless of whether it ultimately does.14 Further,

8 Federal Open Market Committee, “Conference Call of the Federal Open Market Committee on August 1, 2011,”
August 1, 2011, at https://www.federalreserve.gov/monetarypolicy/files/fomc20110801confcall.pdf.
9 U.S. Congress, Hearing of the Senate Committee on Finance, The Debt Limit, 113th Cong., 1st sess., October 10, 2013.
10 Letter from Alastair M. Fitzpayne, Assistant Secretary for Legislative Affairs, to Hon. Jeb Hensarling, Chairman,
Committee on Financial Services, May 7, 2014.
11 See CRS Report R41633, Reaching the Debt Limit: Background and Potential Effects on Government Operations.
12 An example from the 118th Congress is S. 82, the Full Faith and Credit Act. Lawmakers introduced similar bills
during past debt limit debates.
13 Zhiguo He, Arvind Krishnamurthy, and Konstantin Milbradt, “What Makes the US Government Bonds Safe
Assets?” American Economic Review, vol. 106, no. 5 (2016), pp. 519-523.
14 For an example of such effects from the 2013 debt limit episode, see Government Accountability Office, Debt Limit:
(continued...)
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The Potential Economic Effects of a Binding Federal Debt Limit

investors may still view government securities as a riskier investment even if the government
successfully prioritizes payments on Treasuries over other federal obligations if they believe that
the debt limit breach signifies that the federal government is unreliable or unpredictable. In these
cases, interest rates on Treasuries could rise even without a default on those vehicles. Research
found that federal interest rates rose relative to other market transactions during debt limit
episodes in 201115 and 2013,16 when the federal government did not actually default on any
securities. Interest rates recovered quickly after both episodes, but may not if a future episode
affects investor confidence more significantly.
It is also possible, however, that investors will assume that Treasury will ultimately make full
payments on any outstanding securities, and not react negatively to the potential for the debt limit
to bind. If so, interest rates may rise little—if at all—even after a technical default. It is not clear
how likely such a scenario would be, as it would require investors not only to remain calm in a
crisis, but to assume that their fellow investors will do the same. This would be potentially
inconsistent with market experiences during debt limit discussions in 2011 and 2013.
Effects on the Cost of Servicing the Federal Debt
If investors perceive Treasuries as riskier and demand higher interest rates to hold them, the
federal government would have to make larger interest payments in the future. These higher
payments would increase total federal outlays and net deficits moving forward.
Federal statutes contractually obligate the government to pay interest penalties if it does not make
payments in a timely fashion. For example, the government must generally pay interest on tax
refunds paid more than 45 days after the tax filing deadline.17 The Prompt Payment Act generally
requires the government to pay interest on other payments made after they are due, or more than
30 days after receiving an invoice.18 Any debt limit breach that occurs when many such payments
are due would likely impose additional costs on the government, thereby increasing total federal
spending in the short run.
The future path of the federal debt is highly sensitive to changes to the interest rate. CBO
estimated that the debt held by the public would equal 147% of GDP in FY2052 under a
hypothetical “Lower Interest Rate Path” scenario, but that figure rises to 235% of GDP under a
“Higher Interest Rate Path” scenario.19

Market Response to Recent Impasses Underscores Need to Consider Alternative Approaches, GAO-15-476, July 2015,
at https://www.gao.gov/products/gao-15-476.
15 Martin A. Sullivan, “The Great Debt Ceiling Showdown of 2023,” Tax Notes Federal, vol. 178, January 23, 2023.
16 Mark Zandi, “Debt Limit Brinksmanship (Again),” Moody’s Analytics, January 23, 2023.
17 Internal Revenue Service, Interest, updated January 10, 2023, at https://www.irs.gov/payments/interest. See also 26
U.S.C. §6611.
18 See CRS Report R41633, Reaching the Debt Limit: Background and Potential Effects on Government Operations, by
D. Andrew Austin, Clinton T. Brass, and Dawn Nuschler.
19 Congressional Budget Office, “The Long Term Budget Outlook,” Figure 4-1, July 2022, at https://www.cbo.gov/
system/files/2022-07/57971-LTBO.pdf. While the exact levels are subject to considerable uncertainty, this wide range
demonstrates that interest rates have a significant impact on the path of the federal debt.
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The Potential Economic Effects of a Binding Federal Debt Limit

Effects on Financial Markets and the Domestic Economy
Financial markets view federal securities as among the safest capital assets to hold, which
combined with their broad availability makes them a critical part of investor portfolios.20 Given
this factor, along with the high volume of federal debt ($24.1 trillion in marketable debt as of
January 2023), shifts in the perception of federal creditworthiness may disrupt the financial
marketplace.
A rise in the perceived riskiness of federal debt might also have consequences for routine
financial transactions that often depend on the availability and reliability of Treasuries. Large
financial actors in the United States and around the world often use Treasury securities as
collateral for short-term transactions.21 A rise in the likelihood of federal security default may
delay or reduce the level of such transactions, which could lead to slowdowns or reductions in
subsequent economic activity. There is evidence that investors avoided certain Treasury securities
perceived to be “at risk” (those with maturity periods right around the expectation of a binding
debt limit) during the debt limit episode of 2013 and moved their portfolios toward perceived
safer investments. These types of movements increase the general volatility of the financial
marketplace, which can lead to further financial and economic disruption.
The potential adverse effects of a binding debt limit could also include a wide range of
ramifications for the households and businesses in the remainder of the economy. Any downgrade
in the perceived value of federal securities would thereby decrease the value of domestic asset
holdings. Domestic sources hold roughly 70% of federal publicly held debt,22 meaning much of
this sudden loss of wealth would affect households and businesses within the United States. The
remainder would affect foreign asset holders, including foreign central banks.
Effects of Other Cuts to Federal Spending
Nonpayment of Treasuries and any resulting perception of riskiness are not the only ways a
binding debt limit could affect the economy. If the federal government cut or delayed other
spending to comply with the legal debt limit, these cuts or delays could inhibit economic demand
and potentially trigger a recession.
Federal noninterest spending generally falls into four broad categories:
1. payments to individuals, such as Social Security and benefits for low-income
people, such as the Supplemental Nutrition Assistance Program (SNAP);
2. salaries, pensions, and other compensation and retirement benefits for federal
employees and members of the U.S. Armed Forces;
3. in-kind benefits such as Medicare and Medicaid; and
4. purchases for the government’s use, such as military equipment and supplies for
civilian offices.
Delaying these payments, or making them only in part, would likely reduce economic demand.
Recipients of transfer benefits or federal employee benefits would receive less money in the short

20 Moody’s Analytics, “Going Down the Debt Limit Rabbit Hole,” March 2023, at https://www.moodysanalytics.com/-
/media/article/2023/going-down-the-debt-limit-rabbit-hole.pdf.
21 See CRS Report R41633, Reaching the Debt Limit: Background and Potential Effects on Government Operations, by
D. Andrew Austin, Clinton T. Brass, and Dawn Nuschler.
22 CRS calculations based on data from U.S. Treasury and Federal Reserve Board, “Major Foreign Holders of Treasury
Securities,” January 2023, at https://ticdata.treasury.gov/Publish/mfh.txt.
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The Potential Economic Effects of a Binding Federal Debt Limit

term, and would likely curtail their household spending as a result. The government itself would
also demand less in-kind services, supplies, and equipment.
Scale of the Reduction in Economic Activity
Estimating how much this drop in demand would reduce economic activity is difficult. Though
there is considerable variation across studies, prominent estimates, including research from the
Congressional Budget Office23 and Moody’s Analytics,24 found that the spending cuts passed as
part of the Budget Control Act of 2011 had short-run25 fiscal multiplier effects that ranged from
1.1 to 2.3. These findings suggested that the cuts produced a short-run decline in output of $1.10
to $2.30 for every $1 reduction in government spending, depending on the macroeconomic
assumptions used. The exact scale of the short-run fiscal multiplier will depend on which
payments the government does not make in full or on time, how long the debt limit episode lasts,
and the degree to which markets demand higher interest payments on federal debt.
The ultimate impact of these missed or incomplete payments could also depend on the condition
of the economy when they occur. If government spending falls while economic demand is high,
other buyers may fill the government’s place in the market, buying many of the goods the
government would otherwise buy (or fund the purchase of through transfer payments). If other
buyers would partially offset the decline in economic demand, the resulting contraction would be
less severe. However, if demand is soft, there may be fewer buyers to compensate for lost
government spending. Economic demand is currently strong by historical standards, but appears
to be cooling because of the waning impact of the fiscal response to the COVID-19 pandemic and
the Federal Reserve’s recent efforts to lower inflation.26
Stimulus and Automatic Stabilizers
Lawmakers have addressed past recessions with fiscal stimulus to encourage individuals to spend.
This has been done through the enactment of direct federal spending, transfers to individuals, or
expanded liquidity. Fiscal stimulus of this type is most effective when financed by deficits, as
raising taxes leaves households with less money to spend, undermining the goal of the stimulus.
However, under a binding debt limit, any new stimulus measures passed by Congress could not
be deficit financed. Instead, other outlays would need to be cut or delayed even more than they
otherwise would to leave funds available for the new stimulus measures.
Some federal programs, known as “automatic stabilizers,” automatically expand deficits when the
economy enters a recession, without the need for congressional action. For example, when
households’ incomes fall, more households qualify for means-tested benefits such as SNAP and
Medicaid. Similarly, the progressive individual income tax collects less revenue when

23 Congressional Budget Office, “Economic Effects of Reducing the Fiscal Restraint that Is Scheduled to Occur in
2013,” May 2012, at https://www.cbo.gov/sites/default/files/cbofiles/attachments/FiscalRestraint_0.pdf.
24 Mark Zandi, “U.S. Economic Outlook: Policymakers Must Get It Right,” Moody’s Analytics, July 2012.
25 These multipliers measure the effect of government spending on economic activity in the “short run,” meaning the
period before which most prices have had time to adjust to reflect the change in economic demand. Economic theory
suggests that with time, producers will raise prices to account for the increase in government spending, leading to no
“long-term” change in economic output.
26 See CRS Insight IN12091, Will Inflation Continue to Fall?, by Lida R. Weinstock and Marc Labonte.
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The Potential Economic Effects of a Binding Federal Debt Limit

individuals’ incomes fall.27 In normal recessions, automatic stabilizers intentionally provide
timely deficit-financed stimulus.
However, just as with other stimulus, a binding debt limit would inhibit automatic stabilizers, as
the government could not finance them with new debt. Funding automatic stabilizers under a
binding debt limit would require the government to cut other programs by larger amounts than
they otherwise would.
While a debt-limit-induced recession would undermine fiscal policy’s ability to respond to it, the
Federal Reserve would still have the power to attempt to encourage demand by lowering interest
rates. Given the uncertainty surrounding how the financial system would operate in the event of a
binding debt limit, it is also uncertain how that system might react to the Federal Reserve’s
efforts. These efforts might also run counter to the Federal Reserve’s recent focus on raising
interest rates to slow economic demand.

Author Information

Brendan McDermott
Grant A. Driessen
Analyst in Public Finance
Specialist in Public Finance

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan
shared staff to congressional committees and Members of Congress. It operates solely at the behest of and
under the direction of Congress. Information in a CRS Report should not be relied upon for purposes other
than public understanding of information that has been provided by CRS to Members of Congress in
connection with CRS’s institutional role. CRS Reports, as a work of the United States Government, are not
subject to copyright protection in the United States. Any CRS Report may be reproduced and distributed in
its entirety without permission from CRS. However, as a CRS Report may include copyrighted images or
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copy or otherwise use copyrighted material.

27 See “Automatic Stabilizers” section in CRS Report R45780, Fiscal Policy Considerations for the Next Recession, by
Mark P. Keightley.
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