On January 19, 2023, the United States federal government owed a total of $31.4 trillion to Treasury security (Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities) holders. The US had once again hit its national debt ceiling, reigniting the debate on how to properly manage government spending.
The US debt ceiling, that is, the legal limit on how much debt the Treasury can incur, was ratified in 1917 under the Second Liberty Bond Act. Prior to this, Congress would review and either approve or deny each government bond (or package of debt) issued. But when WW1 came around, the US needed a more flexible framework to acquire funding. And so the debt ceiling was born.
Although the debt ceiling has implications for the federal budget, the 2 are in no way the same. The debt ceiling is simply how much the US government can borrow to pay for expenditures in the federal budget such as infrastructure projects, government services, and tax credits. The money has to come from somewhere, and so the government turns to either the general public or itself to sell Treasury securities.
Wait, how does the US government “turn to itself” for money. Well it goes without saying that the government is made up of multiple entities: the Treasury is responsible for collecting and spending taxes (although Congress decides how much should be taxed and where money should be spent). But because the US generally spends more than it receives in taxes, the Treasury has to raise extra funds through selling bonds.
And some of their biggest customers are other government agencies. The Social Security Trust Fund or the Military Retirement Fund will purchase T-bonds and use the interest payments to finance their operations. The vast majority of government debt, however, is publicly owned by the Federal Reserve (who use it for their open market operations, as described here), foreign governments (who use it for their forex policies), banks, insurance companies, pension funds, etc.
Inflation and national debt
The “real value” of government debt is controlled for inflation, that is, the price of a basket of goods or services. An increase in inflation will therefore reduce the real value of the US’s debt, but the nominal value will stay the same – generally speaking, the amount owed to a creditor remains the same even after inflation goes up.
This means that for all loans in general, not just government debt, unexpected inflation transfers “real wealth” (funds accounting for inflation) from lenders to borrowers, as the borrowers can now pay the interest in depreciated money. Applying this to US government debt, surprise inflation transfers “real wealth” from debt holders to American citizens, who finance the issuing of T-bonds through their taxes. (On net, however, obviously sudden inflation won’t enrich most Americans).
So why is this important? Because inflation tends to raise the cost of issuing future US debt. Inflation erodes some of money’s real value, so the creditor will demand additional compensation to make up for that lost purchasing power. Say one day you lend $100 at 10% interest with no inflation. The following day inflation increases to 3% and remains at that level for a year.
On paper, your borrower may still be paying you $10 in interest, but the real value of that money is now $9.7. Assuming inflation continues at 3%, you’ll probably want to increase your future loan’s interest rate from 10% to say, 15% to offset the real value lost through inflation. This is precisely what happens when it comes to national debt. During periods of high inflation, the cost of issuing debt (interest rates) is higher and so is difficult to sustain. Conversely, during periods of low inflation, the cost of issuing debt is lower and is therefore easier to sustain.
The debate on national debt
This isn’t the first time the US has hit its debt limit, and it certainly won’t be the last. Historically, whenever this happens, Congress will usually raise the ceiling. Without any raise, the Treasury could not issue any more bonds, which means no more revenue coming from that debt. What would that mean? At some point, the US government will be unable to pay off their creditors. In other words, default.
It hasn’t happened, but boy have there been close calls, the most notable of which was in 2011. The Obama-led Democrats and congressional Republicans couldn’t agree on whether to raise the debt ceiling, and the debate dragged on until days before a massive interest payment was due – one that the Treasury couldn’t afford to make without borrowing more money. Although the debt ceiling was eventually raised, the delay prompted S&P Global Ratings to downgrade the US’s credit score for the first time (yes, countries are assessed on how safe of a borrower they are). It is estimated that this one move increased US borrowing costs by $1.3 billion.
A US government default would be catastrophic. Not only would T-bond interest rates, and thus, all other, interest rates increase in the wake of the credit downgrading (thereby severely depreciating aggregate demand and hence wages, employment numbers, and GDP), but the international community will never look at the American government with the same confidence and faith as before.
As Janet Yellen, Secretary of the US Treasury, put it: “Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans and global financial stability.”
At the end of the day, the ceiling doesn’t actually help the US’s all-time high levels of government debt – that’s controlled by taxation and/or spending. It’s unlikely that the US will default on its debt anytime soon. But it’s important to consider the implications of the constant disagreement on raising the debt ceiling every time it’s approached; if there always seems to be a modest chance of default, might the US government lose its status as the world’s safest place to invest?
Econ IRL
Digital advertising has undoubtedly changed the way firms grow their brand and reach customers. But measuring the actual returns of digital advertising can be difficult and result in overspending. This week’s paper seeks to do just that through a field experiment on Yelp with over 18,000 restaurants.
The setup is especially useful for a few reasons. Firstly, the businesses are all in the same industry, food, providing heterogeneity from which stronger conclusions can be deduced. Secondly, most of these restaurants didn’t advertise prior to the experiment being conducted, allowing for a before-and-after analysis on the effects of digital advertising. Thirdly, Yelp comes with plenty of advertising features and records useful metrics covering a business’s outreach.
The authors assign over 7,000 restaurants standard ad packages for three months, sending out around 500 million total search impressions. Those restaurants had a 19% increase in their page views, and an up to 14% increase in their customers’ purchase intention outcomes. These effects were consistent regardless of the restaurant’s chain status, average review rating, age, or price level.
‘Till next time,
SoBasically