Compared to what could have happened, it was almost the least bad outcome possible. The deal that President Joe Biden made with Kevin McCarthy, the Republican chairman, to avert a US national debt was made under duress. No other major economy has a debt ceiling, let alone a routine habit of playing chicken with it. But the final package, which passed by a surprisingly large majority in the House of Representatives on Wednesday evening and is likely to be approved by the Senate this weekend, was modest. It shouldn’t take the specter of financial catastrophe to agree on what was a petty bipartisan compromise in budgetary terms.
It nevertheless marks another victory for the serially underrated Biden and a moment of relief for McCarthy, who sidelined the most extremist members of his party.
The deal as a whole also represents a very positive contrast to the last time it came close to the debt ceiling in 2011. fiscal discipline plan with the newly elected Tea Party Republicans under the same threat.
The result was an avoidance of a national debt, but at a significantly higher cost than the Biden-McCarthy deal. In a fragile phase of the US recovery from the 2008 financial crisis, Obama agreed to the so-called sequestration rule, which cut US spending in real terms by $2.4 trillion over a decade. This was a contraction move at just the wrong time in the US business cycle, when interest rates were at zero and private sector investment was still weak. Growth in the US suffered as a result.
The deal between Biden and McCarthy, on the other hand, could even turn out to be mildly positive. It cuts US spending by $136 billion over the next two years, which could ease some of the pressure on the US Federal Reserve to raise interest rates. At a time of full unemployment and strong consumer demand, that means it’s counter-cyclical. More importantly – and unlike the Obama deal with the Tea Party – it does no harm.
Hardline members of the Republican Freedom Caucus wanted to scrap Biden’s Inflation Reduction Act, which funds hundreds of billions of dollars in green energy over the next decade. They also wanted to cut the budget to modernize the much-depleted Internal Revenue Service. Their plan would have cut US nondefense spending in half over the next 10 years. Finally, they would have only extended the debt limit to 2024, which would have created another very destabilizing battle during a presidential election year.
On each of these points, Biden got his way. The debt ceiling has been suspended until early 2025, eliminating the election year risk. The spending limits are modest and expire after two years. The IRS budget was largely preserved and the IRA emerged intact. This is a great relief to the markets, to the dollar’s status as the global reserve currency, and to Biden’s ability to rule in a relatively calm atmosphere for the remainder of his term. On this occasion, the American Center was held.
Against that is the cost of maintaining America’s nonsensical debt ceiling. The US has a growing long-term debt problem that needs to be addressed on both the spending and tax sides. That requires bipartisan negotiations on rational terms. This time a self-inflicted disaster was averted. But at some point, the American system is likely to miscalculate and blow itself up. The sooner the debt ceiling is abolished and replaced by sensible measures to improve debt sustainability, the better.