Doomsday is the day after tomorrow: what would the default do?

There are many stories about doomsday, i.e. the breaching of the debt-ceiling limit of US$16.7 trillion, which would basically force a balanced budget amendment on the Federal government. As I noted, and Dean Baker too (although I disagree that if the dollar was not the key currency it would mean more jobs, but that's for another post), it is unlikely that the default would lead to a dollar crisis. The position of the dollar is relatively safe, if nothing else because Europe and Japan are in crisis, and China's currency is not convertible.

On the other hand, the default will impose severe austerity. Note that deficits have been falling since Obama took office, as can be seen in the figure below, from about US$1.5 trillion, in the first year of the Obama administration (inherited from Bush) to around US$1 trillion last year, and an estimated smaller number this year (without a default).

If a balanced budget was imposed the immediate impact would not be a decrease of spending of US$1 trillion, but that would be what would have to be achieved over a full fiscal year. Even if you assume a small multiplier of say 1.2, that would imply a staggering fall in output of around 8% of GDP. Not a recession, but a huge one. Note that the deficits will actually not decrease, since revenues would collapse, and with it renewed efforts to cut spending.

The fact that something as simple as the multiplier, and as clear in the historical record, and supported by tons of empirical data, could be ignored is incredible. But remember that the people behind this in Congress do NOT believe in evolution, and do think we are living in the end of times. Maybe that's the reason they want to default! Of course all of this could be avoided with a simple vote. Hope springs eternal.

Comments

  1. " China's currency is not convertible."

    Few currencies are convertible. Most are only exchangeable.

    A very important difference that makes Gold Standard thinking inapplicable.

    ReplyDelete
  2. Re the so called "national debt", I'd like to ask you to consider joining my campaign to give it a new name: "national savings". See:

    https://sites.google.com/site/nationaldebtsave/

    ReplyDelete
  3. http://www.epi.org/publication/deal-deal-shutdown-debt-ceiling-biggest/

    ReplyDelete

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