U . S . D E P A R T M E N T O F T H E T R E A S U R Y

Introduction

The United States has never defaulted on its 

obligations, and the U. S. dollar and Treasury 

securities are at the center of the international 

financial system. A default would be 

unprecedented and has the potential to be 

catastrophic: credit markets could freeze, the 

value of the dollar could plummet, U.S. 

interest rates could skyrocket, the negative 

spillovers could reverberate around the world, 

and there might be a financial crisis and 

recession that could echo the events of 2008 

or worse. 

Political brinksmanship that engendgers even 

the prospect of a default can be disruptive to 

financial markets and American businesses 

and families. The closest historical precedent 

is the debt ceiling impasse in 2011, around 

which time consumer and business 

confidence fell sharply, and financial markets

went through stress and job growth slowed. 

In 2011, U.S. government debt was 

downgraded, the stock market fell, measures 

of volatility jumped, and credit risk spreads 

widened noticeably; these financial market 

effects persisted for months. To be sure, 

other forces also played a role, but the 

uncertainty surrounding whether or not the 

U.S. government would pay its bills took a toll 

on the economy. An additional consideration 

now is the government shutdown that started 

October 1. If the shutdown is protracted, the 

economy could be weakened, making the 

expansion even more susceptible to the 

adverse effects from a debt ceiling impasse 

than prior to the shutdown.

It is clear from economic theory and evidence 

that lower stock prices and wider risk spreads 

have adverse effects on private spending, all 

else equal. Because the debt ceiling impasse 

contributed to the financial market 

disruptions, reduced confidence and increased 

uncertainty, the economic expansion was no 

doubt weaker than it otherwise would have 

been. So far this year, Treasury yields have 

been rising on balance, which means that any 

adverse effects from financial market 

disruptions caused by a debt ceiling debate 

may not be offset as it was in 2011.

THE POTENTIAL MACROECONOMIC 

EFFECT OF DEBT CEILING BRINKMANSHIP

OCTOBER 2013

In 2011, U.S. debt was downgraded,the 

stock market fell, measures of volatility 

jumped, and credit risk spreads widened 

noticeably.
U.S. DE PARTM ENT OF T HE TRE AS URY 2

THE POTENTIAL MACROECONOMIC EFFECT OF DEBT CEILING BRINKMANSHIP

The Experience of 2011 and the Links 

to the Economy

The financial market stress that developed in 

August of 2011 persisted into 2012 even 

though Congress raised the debt ceiling prior 

to the exhaustion of extraordinary measures.

In this report, we discuss in more detail some 

channels through which a similar episode 

might harm the economic expansion. In 

brief, reduced household and business

confidence, lower equity prices, volatility in 

the stock market and increased corporate and 

household borrowing costs all tend to 

undermine the economic expansion. 

Household and Business Confidence

From June to August 2011, consumer 

confidence fell 22 percent and business 

confidence fell 3 percent. Measures of both 

had already begun to fall earlier in 2011, in 

part because of developments abroad, but as 

the debate about the debt limit grew, these 

measures of confidence fell further. 

Moreover, it took months before confidence 

recovered fully, even though, in the end the 

debt limit stand-off was resolved. Although 

these measures of private-sector confidence 

are not measures of spending or the direct 

costs of doing business, they capture the 

mood of the private sector with regard to 

spending.

Financial Market Effects

Financial market conditions have a direct 

effect on economic activity. A good deal of 

household wealth is held in financial assets, 

and much of household and business 

spending is funded by borrowing. Thus, 

lower asset prices and higher borrowing costs 

tend to weigh on private spending, and greater 

uncertainty about asset prices, borrowing 

costs, and economic activity can make 

households and businesses reluctant to spend. 

Stock prices, stock price volatility, credit risk 

spreads, and mortgage spreads all deteriorated 

in August 2011 and recovered only after many 

months. 

Consumer Confidence

Index, August 2011 = 100

FIGURE 2

SOURCE: REUTERS/UNIVERSITY OF MICHIGAN, CONFERENCE BOARD. 

Small Business Optimism

Index, August 2011 = 100

FIGURE 3

SOURCE: NFIB. 

 95

 100

 105

 110

Feb '11

Mar '11

Apr '11

May '11

Jun '11

Jul '11

Aug '11

Sep '11

Oct '11

Nov '11

Dec '11

Jan '12

Feb '12

NFIB

Small Business 

Optimism

 80

 100

 120

 140

 160

Feb '11

Mar '11

Apr '11

May '11

Jun '11

Jul '11

Aug '11

Sep '11

Oct '11

Nov '11

Dec '11

Jan '12

Feb '12

Conference 

Board

Consumer

Confidence

U. Mich

Consumer

Sentiment

AUG 2011

AUG 2011
U.S. DE PARTM ENT OF T HE TRE AS URY 3

THE POTENTIAL MACROECONOMIC EFFECT OF DEBT CEILING BRINKMANSHIP

Equity Market Prices 

The S&P 500 index of equity prices fell about 

17 percent in the period surrounding the 2011 

debt limit debate and did not recover to its 

average over the first half of the year until 

into 2012. Roughly half of US households 

own stocks either directly or indirectly 

through mutual funds or 401(k) accounts, so 

this fall in equity prices reduced household 

wealth across a wide swath of the economy. 

Between the second and third quarter of 2011, 

household wealth fell $2.4 trillion. A decline 

in household wealth tends, all else equal, to 

lead to a decline in consumption spending, 

and consumer spending accounts for roughly 

70 percent of GDP. Moreover, because a 

good deal of retirement savings is invested in 

stocks, lower stock prices reduce retirement 

security – from the second to the third quarter 

of 2011, retirement assets fell $800 billion.

Businesses are also affected by stock prices

because they rely on both debt and equity 

financing. When stock prices fall, investment 

or other spending to expand a business is 

more costly. The effects on households and 

businesses, moreover, are reinforcing. Less 

capacity and willingness of households to 

spend, when businesses have less incentive to 

invest, hire, and expand production, all lead to 

weaker economic activity.

Stock Market Volatility

One common measure of volatility or 

uncertainty in financial markets is the 

―implied volatility‖ of stock prices, measured 

by the VIX. The VIX jumped around the 

S&P 500

Index

 1,000

 1,200

 1,400

 1,600

Feb '11

Mar '11

Apr '11

May '11

Jun '11

Jul '11

Aug '11

Sep '11

Oct '11

Nov '11

Dec '11

Jan '12

Feb '12

S&P 500

Index

FIGURE 4

SOURCE: S&P. 

VIX Market Volatility

Index

 -

 10

 20

 30

 40

 50

Feb '11

Mar '11

Apr '11

May '11

Jun '11

Jul '11

Aug '11

Sep '11

Oct '11

Nov '11

Dec '11

Jan '12

Feb '12

VIX

Market Volatility 

Index

FIGURE 5

SOURCE: CBOE. 

AUG 2, 2011

AUG 2, 2011

Between the second and third quarter of 

2011, household wealth fell $2.4 trillion. 

In the summer of 2011, corporate risk 

spreads on BBB-rated corporate debt 

jumped 56 basis points.
U.S. DE PARTM ENT OF T HE TRE AS URY 4

THE POTENTIAL MACROECONOMIC EFFECT OF DEBT CEILING BRINKMANSHIP

time of the 2011 debt ceiling impasse, roughly 

doubling, and remained elevated for months. 

Greater volatility can lead investors to pull 

back from any investment they perceive as 

risky, a development that tends to raise the 

cost of borrowing for households and 

businesses. Moreover, volatility can cause 

households and firms to pare back spending 

to accumulate larger reserves of cash to buffer 

possible future adverse developments.

Corporate Credit Risk Spread

Investors’ willingness to lend to nonfinancial 

corporations is often summarized by credit 

risk spreads—that is, how much higher yields 

on private securities are than yields on 

comparable maturity Treasury securities. If 

investors are less willing to invest, they 

demand a higher return for that investment. 

From the borrowers’ perspectives, wider 

credit spreads imply a higher cost of funding 

for a given level of Treasury rates. Higher 

funding costs lead to less spending on 

investment or other outlays that are financed. 

In 2011, corporate risk spreads on BBB-rated 

corporate debt jumped 56 basis points, and

the wider spreads persistedb into 2012. A 

portion of the widening in this risk spread 

likely reflects the sovereign debt crisis in 

Europe among other factors, which both 

increased corporate risks and pushed down 

Treasury yields. The adverse effect on 

business was muted somewhat because the 

total cost of borrowing for businesses did not 

rise in line with the wider spreads. With

Treasury yields rising this year, a widening in 

spreads would lead to an increase in yields on 

corporate debt. While corporate debt spreads 

are most applicable to borrowing costs for 

large institutions, in times of stress, banks 

tighten terms and standards on loans to small 

businesses, as well.

Mortgage Spread

Similar to corporate credit risk spreads, the

spread of mortgage rates over yields on 

Treasury securities reflects investors’ 

willingness to lend to finance housing. 

Mortgages involve some risk, and so an 

increase in risk aversion on the part of 

investors leads to a widening of mortgage 

spreads, and for a given level of Treasury 

Ten-Year BBB Corporate Bond Spreads

Basis Points over Treasuries

 150

 200

 250

 300

Jan '11

Mar '11

May '11

Jul '11

Sep '11

Nov '11

Jan '12

Mar '12

May '12

Ten-Year BBB 

Corporate 

Bond Spreads

BPS over Treasuries

FIGURE 6

SOURCE: S&P, FEDERAL RESERVE.

 -

 25

 50

 75

 100

 125

 150

Feb '11

Mar '11

Apr '11

May '11

Jun '11

Jul '11

Aug '11

Sep '11

Oct '11

Nov '11

Dec '11

Jan '12

Feb '12

Thirty-Year 

Conventional 

Mortgage 

Spreads

BPS Over

Treasuries

FIGURE 7

30-Year Conventional Mortgage Spreads

Basis Points over Treasuries

SOURCE: WALL STREET JOURNAL, FEDERAL RESERVE. 

AUG 2, 2011

AUG 2, 2011
U.S. DE PARTM ENT OF T HE TRE AS URY 5

THE POTENTIAL MACROECONOMIC EFFECT OF DEBT CEILING BRINKMANSHIP

yields, wider mortgage spreads increase 

mortgage rates, raising the cost of buying a 

home. Higher rates also mean that refinancing 

does not improve cash flow as much, which 

in turn restrains consumption spending. In 

the late summer of 2011, the 30-year 

conventional fixed-rate mortgage spread 

jumped by as much as 70 basis points and the 

wider spreads lasted into 2012. For an 

average mortgage of $235,000 at that time, 70 

basis points more on a mortgage rate would 

increase monthly payments by about $100 per 

month. As noted above, sovereign debt 

concerns in Europe were affecting domestic 

financial markets, and part of the mortgage 

spread widening likely reflects those 

developments. Those same concerns pushed 

down Treasury yields, so on balance, 

mortgage rates actually declined even as the 

spreads widened. If the widening of mortgage 

spreads that resulted from the debt ceiling 

debate were to take place now, when yields on 

Treasury securities have been rising, the result 

would be higher mortgage rates that would 

restrain the housing market and household 

spending.

How does this information relate to 

the current situation? 

Real GDP expanded at a 1.8 percent annual 

rate in the first half of 2013, and last month, a 

consensus of private-sector economists 

forecast real GDP to accelerate to a 2.4 

percent annual rate in the second half and 

then to expand 2.8 percent in 2014. As 

economic activity strengthens, labor market 

conditions should improve further, creating 

new jobs and maintaining the downward 

trajectory of the unemployment rate. The 

government shutdown that began October 1 

puts that outlook at risk. Private-sector 

economists have estimated that a weeklong 

shutdown could slow GDP growth in the 

fourth quarter by over a quarter percentage 

point, while a longer shutdown could have a 

substantially greater effect, perhaps even 

causing a recession.1 If such projections 

prove accurate, the weaker-than-expected 

economic expansion would be even more 

susceptible to the adverse effects from a debt 

ceiling impasse than prior to the shutdown. A 

protracted debate about the debt ceiling could 

spark renewed financial market stress, and a

fall in stock prices and wider credit spreads 

would depress spending from the private 

sector. In addition, increased uncertainty or 

reduced confidence could lead consumers to 

postpone purchases and businesses to 

postpone hiring and investments. A precise 

estimate of the effects is impossible, and the 

current situation is different than that of late 

2011, yet economic theory and empirical 

evidence is clear about the direction of the 

effect: a large, adverse, and persistent 

financial shock like the one that began in late 

2011 would result in a slower economy with 

less hiring and a higher unemployment rate 

than would otherwise be the case.

 

 

1 See, for example, Mark Zandi, written testimony 

before the Senate Budget Committee, September 24, 

2013.

In the late summer of 2011, the 30-year 

conventional fixed-rate mortgage spread 

jumped by as much as 70 basis points.
U.S. DE PARTM ENT OF T HE TRE AS URY 6

THE POTENTIAL MACROECONOMIC EFFECT OF DEBT CEILING BRINKMANSHIP

We may be starting to see some tentative signs 

that the current debate is affecting financial 

markets. Although the price moves are small 

and could easily reverse quickly, the fact that 

yields on Treasury bills that mature at the end 

of October are higher than bills that mature 

immediately before or after, might suggest 

nascent concerns about possible delays in 

payments on those bills. If market 

participants were to lose confidence in the 

United States’ willingness to repay its debts, 

the adverse effects seen in 2011 could 

reappear, and even push up yields on Treasury 

securities. Such a rise in Treasury yields 

would also raise the cost of financing the 

government’s debt and worsen the fiscal 

position of the government. 

In the event that a debt limit impasse were to 

lead to a default, it could have a catastrophic 

effect on not just financial markets but also 

on job creation, consumer spending and 

economic growth—with many private-sector 

analysts believing that it would lead to events 

of the magnitude of late 2008 or worse, and 

the result then was a recession more severe

than any seen since the Great Depression. 

Considering the experience of countries 

around that world that have defaulted on their 

debt, not only might the economic 

consequences of default be profound, those 

consequences, including high interest rates, 

reduced investment, higher debt payments, 

and slow economic growth, could last for 

more than a generation. 

not only might the economic consequences 

of default be profound, those consequences

... could last for more than a generation.