You’ve probably been hearing about the debt ceiling and the national debt in the news for a while. Should the U.S. government raise the debt ceiling? Does the government need to raise tax rates instead? How does the debt ceiling and national debt affect me? These are some of the questions that may come to mind every time you watch the news.
What is the Debt Ceiling?
Every day the government spends more money than it has, and as a result, the government has to borrow money (sell debt) to cover for that deficit. There was a law passed back in 1917 determining the debt ceiling (the maximum amount that the government can borrow), but of course, the amount has been changed many times since then. In fact, since 1962, the debt ceiling has been raised 74 times. Currently, the debt ceiling is capped at $14.3 trillion, an amount that the government is anticipated to reach next month.
What Happens When the Government Reaches the Debt Ceiling?
The government has several options for when they reach the debt ceiling:
- Raise the debt ceiling once again
- Balance the budget (stop overspending)
In order for the government to balance the budget, deep spending cuts would need to be made or an increase in taxes would need to happen. Since reaching an agreement in either of these issues is near impossible, the other option may be a more realistic one – raise the debt ceiling.
What Happens if the Debt Ceiling is Not Raised by Aug. 2?
If the government fails to raise the debt ceiling, it could have a huge effect on not only the world economy but also on your personal finances. Not only could the U.S. not be able to pay its bills in full but other economic factors, such as interest rates could be affected as well. The full consequences of failing to meet this deadline are not known, but most economists agree that they are not good.
Effect of National Debt on Interest Rates and Your Wallet
The effect of the national debt on interest rates is not completely clear. Some economists argue that the national debt has no impact on interest rates, while others say that there is a strong correlation.
If the debt ceiling is not increased, the government would need to prioritize its obligations, some bills would not be paid, which could lead to a downgrade of the U.S. credit rating – the same as how an individual’s credit score drops when bills are not paid on time. This, in turn, would affect the demand of U.S. securities including the U.S. dollar and bonds.
Similarly to what happens to a consumer applying for a loan with a low credit score, the U.S. would have to pay a higher price for its debt. In other words, the U.S. would have to pay a higher interest rate on its debt (savings bonds, for example) to those who buy their securities in order to offset the higher risk.
The increase in cost of U.S. debt (interest rates) can also affect consumers since rates on consumer loans, like mortgages or car loans, could increase as well. Banks and lenders fund loans with capital from investors. If the U.S. government is offering a higher interest rate to those who purchase its debt, then these investors may buy U.S. debt instead of investing in a lender. This means that a lender would have to increase interest rates in order to attract investors and more loans can be funded.
There is no sure way of knowing exactly what will happen on August 2rd, when the deadline for a debt ceiling increase expires. One thing is certain, if you’re considering taking a loan to make a large purchase, it may be a good idea to do it soon in order to lock-in a low interest rate, should interest rates go up as a result of the increase in national debt.