The turn of the calendar to 2025 brought with it the end of the federal debt limit suspension. Congress is now on the clock to reach an agreement on raising the debt ceiling to prevent the United States from defaulting on its debt.
“While the expectation is for the debt ceiling to eventually be raised, the narrow House GOP majority, the number of Republican members of Congress who never have and likely never will vote to raise the debt limit, and the political drama previewed in the December 2024 government funding debate will likely introduce volatility to the process,” says Washington Policy Analyst Ed Mills.
Below, we’ll dive into key questions surrounding the debt ceiling and provide Mills’ and Chief Economist Eugenio Alemán’s thoughts on how this situation will be resolved.
What is the debt ceiling?
Lawmakers in Washington set government spending and revenue plans every fiscal year, usually producing a shortfall that many of us know as the federal budget deficit. The accumulation of these fiscal deficits is what is called the debt of the US government. The debt ceiling limits the amount of borrowing that can take place to pay for the deficits that have occurred and were approved by Congress in the past. It is not related to future expenditures. Since the suspension of the debt ceiling in June 2023, the outstanding debt in the US has risen from $31.4 trillion to $36.1 trillion.
The government’s overall borrowing authority is separate from its yearly revenue and spending authority, although the two often create political tension at the same time. Typically, the debt ceiling is raised without much fanfare, but occasionally it’s used as a negotiating point within larger political debates.
While the Treasury can employ what are called “extraordinary measures” to fund the government as the debt ceiling is reached, thus extending the deadline, at some point, the ability to use these measures would run out.
What happens if the United States defaults on its debt?
A default on US debt has never occurred, and need not occur, as the US does not lack resources to pay its debt. If at any point the US does default on its debt, it will be self-inflicted. If the debt ceiling is not increased, suspended or even eliminated, prioritization of debt payments is a potential initial route, but credit rating agencies would probably take those measures as representing a default. If this happens, it will reprice financial risks across the US and global economy, increasing interest rates and making the problems for the US economy worse.
At some point in time, the US government will have no alternative but to make draconian cuts to expenditures and/or increase taxes to stabilize, which will send the US economy into a severe recession. That is, this event will affect the government’s ability to meet its spending obligations, which include Social Security and Medicare in addition to interest payments.
Any missed payments would accrue interest, raising the costs for government functions. Additionally, US debt ratings would likely be downgraded, increasing the cost of borrowing when the debt ceiling is eventually raised.
How would investors be impacted by a default?
Debt ceiling uncertainty likely will lead to volatility for equity market participants, and investor confidence would be severely affected by a default. Furthermore, US debt serves as the benchmark for the global bond market. Any disruptions would likely ripple across financial markets in the United States and abroad and could lead to a recession, says Alemán.
How do we expect the debt ceiling debate to play out?
The debt limit is subject to a 60-vote threshold in the Senate, requiring Democratic support for its passage. Using the most recent debt limit debate in 2023 as a guide, we would expect the X-date – the day when the US government can no longer fulfill its debt obligations through the use of extraordinary measures – to occur at roughly midyear, and the debt limit debate will accordingly become a priority in the first half of 2025. Mills identified the March 14 expiration of the current continuing resolution funding the government as a potential catalyst and timeframe for raising the debt limit.
