The True Costs of Flirting with Default

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February 6, 2014

Contact:    Brian Reil    (202) 454-1334

The economic consequences of a default on US debt, or even another congressional confrontation that threatens such a default, are generally believed to be severe. But now a team of noted economists at the Peterson Institute for International Economics has spelled out the true costs of such fiscal irresponsibility to the US economy and just how those self-inflicted wounds erode American global leadership.

The research explains how lurching from government breakdown to breakdown has damaged an already fragile US economic recovery and will continue to do more harm. The damage from last year's threat of default includes higher borrowing and mortgage costs (nearly $500 a month increase on average for mortgages), suppressed investment, and 750,000 people added to the unemployed rolls. Even US Treasury securities, long held as a completely safe asset, may now have up to a 10 basis point risk premium priced in, raising federal debt service costs as well as financial uncertainty.

US lawmakers face yet another fiscal deadline on February 7, when the debt limit needs to be raised. Without additional room to borrow, the US Treasury Department warns that it will be unable to meet all of its financial obligations by late February—that is, it risks default. Even flirtations with default do harm, as this Peterson Institute study documents. Given those costs, Congress and President Barack Obama should agree on a debt ceiling increase ahead of the deadline, whatever their differences over the budget.

"The direct costs of these fiscal follies are already substantial, as the essays in this report make clear," writes Adam S. Posen, president of the Peterson Institute. "There is no economic justification for America's legislators to behave as badly as their counterparts in far poorer and less solidly democratic countries do—and there certainly is significant damage done by their even threatening to do so."

The series of recent fiscal disputes have also undermined the United States' leadership role in the global economy and more of the same threatens to accelerate the US decline. Among the other long-term effects discussed in the study are that the purchasing power of the dollar will decrease relative to other currencies and investors may meaningfully diversify their reserve holdings into currencies other than dollars.

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This report was funded by a grant from the Peter G. Peterson Foundation. The statements made and views expressed are solely those of the individual authors.

About the Peterson Institute for International Economics

The Peterson Institute for International Economics is a private, nonprofit institution for the rigorous, open, and intellectually honest study and discussion of international economic policy. Its purpose is to identify and analyze important issues to making globalization beneficial and sustainable for the people of the United States and the world and then to develop and communicate practical new approaches for dealing with them. The Institute is widely recognized as nonpartisan. It receives its funding from a wide range of corporations, foundations, and private individuals from the United States and around the world, as well as from income on its endowment.

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