Here’s what House Speaker McCarthy’s chaotic election means for the economy and debt ceiling

Written by ABC AUDIO on January 11, 2023

(NEW YORK) — House Speaker Kevin McCarthy, R-Calif., emerged with gavel in hand on Saturday after fierce Republican negotiations, but the concessions he made in the process have heightened concern over a potential economic crisis later this year.

The empowerment of far-right House members in recent days has raised the risk of contentious, high-stakes negotiations over how the federal government should pay for past debts and allocate future spending, economists and budget experts told ABC News.

Failure to reach an agreement before fast-approaching deadlines would send financial markets into turmoil, raise interest rates at a moment when elevated borrowing costs already weigh on economic activity and all but ensure a recession, they added.

Within months, Congress will need to pass two measures in order to avert economic disruption: a debt-limit increase that allows the U.S. government to borrow money for past expenditures, ensuring that the nation continues paying creditors what it owes; as well as a budget that keeps the government funded for next fiscal year.

The faction of conservative Republicans that exerted leverage in the speaker vote has indicated it would not raise the debt limit unless Democrats agree to significant spending cuts; the Biden administration, however, has said it will not take part in policy negotiations conditioned upon the annual borrowing hike.

Sharp spending cuts put forward by some Republicans, meanwhile, risk gridlock over next year’s budget, which could cause a government shutdown that halts some federal payments, economists and budget experts said.

“The events of last week are quite disconcerting,” Shai Akabas, director of economic policy at the Bipartisan Policy Center. “It’s going to make passing any legislation more difficult than usual, and it’s never easy under a divided government to start with.”

“It is a serious risk for the U.S. economy and for Americans’ financial wellbeing,” he added.

Here’s what you need to know about what recent turmoil in the House of Representatives means for the U.S. economy:

Debt limit

The dispute among Republicans over McCarthy centered in part on the party’s approach to the nation’s debt limit, the amount of money that the U.S. is legally permitted to borrow in order to cover its debt.

Since yearly spending by the federal government exceeds tax revenue, the U.S. has accrued tens of trillions of dollars in debt, requiring the country to make ongoing payments so that it doesn’t default on outstanding loans.

In turn, Congress annually passes a measure that allows the U.S. Treasury to increase the amount it can borrow. In some years, the debt-limit increase has become a political lightning rod, setting off debate over the nation’s fiscal responsibility. In 2011, for instance, Congressional Republicans pressured then-President Barack Obama to agree to some spending cuts in order to win their support for a debt-limit hike.

In his effort gain the support of far-right House members, McCarthy agreed to refuse an increase in the debt limit unless Democrats agree to major spending cuts, the New York Times reported.

A dispute over the debt limit will reach a tipping point within months, according to Akabas, who said the organization projects the government will fail to meet its debt obligations at some point in the middle of this calendar year.

Failure to raise the debt limit and ensuing default on U.S. debt — which have never happened before — would cause immense harm to the U.S. and global economies, since the trustworthiness of U.S. Treasury bonds amounts to a cornerstone of domestic and international investment, economists and budget analysts said.

As confidence in U.S. borrowers falls, interest rates on loans for some businesses would rise, slowing economic activity as the U.S. already faces elevated recession risk, they said. Moreover, the stock market would falter, threatening the retirement savings of millions of Americans, they added.

“A default on the debt would be a catastrophe for financial markets and a catastrophe for America’s standing in the world,” Daniel Bergstresser, finance professor at the Brandeis International Business School, told ABC News.

“The American political and economic system is great enough that many treat US Treasury obligations as being as close to a sure thing as exists,” he added, noting that consequences would likely include a fall in the value of the U.S. dollar.

A default on U.S. debt could shed three million jobs from the economy, drive up the cost of a 30-year mortgage by an average of $130,000 and shrink 401(k) savings for a typical worker near retirement by $20,000, according to a report from center-left think tank Third Way.

“If we violate the debt limit for any significant portion of time, we’re almost certain to push the economy into a recession,” Zach Moller, director of the economic program at Third Way, told ABC News.

Akabas, of the Bipartisan Policy Center, described the economic consequences of U.S. debt default as a “conflagration of risks.”

“It’s uncharted waters,” he added. “It would likely bring costs for the U.S. taxpayer, the American economy and the global economy.”

Government shutdown

In addition to covering its previous expenses, the federal government will need to reach an agreement on how it should allocate money for next fiscal year, which begins in October.

If Congress does not pass a budget by then, the U.S. government will shut down, as agencies struggle to sustain government programs and pay federal employees.

A group of far-right Republicans has called for major cuts to government spending that would set the nation on course to balance its budget in 10 years.

As part of concessions made to the conservative faction, McCarthy has vowed to advocate for sharp cutbacks that include a shrinking of entitlement programs like Medicare and Social Security — bulwarks of financial health for many older Americans, the New York Times reported.

Spending cuts on the scale demanded by far-right Republicans would dramatically curtail federal programs, though specifics remain murky since lawmakers have yet to put forward a detailed proposal, economists and budget analysts said.

“Balancing the budget in 10 years is too heavy a lift to be a serious policy proposal,” Maya MacGuineas, president of the Committee for a Responsible Federal Budget in Washington, which advocates for fiscal responsibility through spending cuts and tax hikes.

“The policy they’re asking for needs to be achievable,” she told ABC News.

Meanwhile, if Congress fails to hash out a budget and the government shuts down, the turmoil could have far-reaching effects, including the closure of some national parks and cuts to government services like passport processing.

“While disruptive, shutdowns aren’t disastrous,” she said.

A government shutdown would also impose some economic pain, as the nation sees a reduction of some programs on which Americans rely and a pause in work for some federal employees, Akabas said.

“It’s certainly not good for the economy,” he said.

MacGuineas said concessions made to far-right Republicans in recent days have left her uncertain about how negotiations over the debt limit and budget will be resolved.

“It makes my head hurt,” she said. “I don’t know – and that makes me very uncomfortable.”