Janet Yellen is right. Congress should abolish the debt ceiling (Guest Opinion by Chandan Jha & Sudipta Sarangi)

Treasury Secretary Janet Yellen speaks to lawmakers during a House Committee on Financial Services hearing on Capitol Hill in Washington, Wednesday, Dec. 1, 2021. (AP Photo/Amanda Andrade-Rhoades)

By Chandan K Jha & Sudipta Sarangi

Chandan K. Jha is an associate professor of finance at Le Moyne College, in Syracuse. Sudipta Sarangi is a professor of economics at Virginia Tech and author of “The Economics of Small Things.”

In her Nov. 16 letter to the leaders of the Congress, Treasury Secretary Janet Yellen raised concerns that the U.S. government might run out of sufficient funds to finance the operations of the federal government beyond Dec. 15. She requested the congressional leaders to raise or suspend the debt limit to continue the operations of the U.S. government and to avoid government shutdown.

The debt limit, or ceiling, is the upper limit on the U.S. government borrowings at any given point in time. The federal government uses its borrowings along with the tax revenues to fund its operations, including salaries to federal employees, spending on federal programs such as Social Security and Medicare, making interest and principal payments on existing debt, cover tax refunds, and so on.

An arbitrary limit

Historically, all Treasury bonds needed legislative approval. That was particularly tedious when millions of dollars were needed to finance World War I. Therefore, legislation was passed to abolish the need for congressional approval and the Treasury could issue bonds as long as it stayed within the debt limit set in 1939 by the Congress. This created a new problem that exists even today: the debt ceiling, an arbitrary value devoid of any economic or financial meaning. So, as the Congress keeps approving new spending, the federal government typically runs out of money to finance its operations and the debt ceiling has to be raised repeatedly.

The consequences

One consequence of the debt ceiling is government shutdowns, when many non-essential government services (like national parks) are suspended due to lack of resources resulting from the failure of the Congress to pass and the president to sign budget legislation for the coming fiscal year. For instance, because of this political impasse, approximately 800,000 federal employees were either furloughed or had their paychecks delayed during the longest government shutdown from Dec. 22, 2018, to Jan. 25, 2019. Another particularly disastrous impact of not raising the debt ceiling could result in the U.S. Treasury being unable to honor its outstanding debt. If the U.S. government has to default on its obligations, i.e., Treasury securities or the best risk-free financial instrument, this will lead to a severe financial crisis and will likely send the world economy into recession. Not surprisingly, therefore the Treasury’s borrowing limit has been raised multiple times.

Demand for abolishing the debt ceiling

Raising the debt ceiling is a complicated process requiring Congressional approval. In recent years, it has become a source of political mileage for the opposition. To avoid the uncertainty and the political drama, many have proposed that the U.S. should get rid of this arbitrary limit and join the list of most developed countries that have no debt ceiling. This is exactly what Yellen is asking for. Her argument is that the Treasury only pays for the bills that are already approved by the Congress. Most of it falls in the category of having been approved and incurred by previous governments. Hence it makes no sense to limit the ability of the Treasury and the current president to meet these obligations by imposing an arbitrary limit on the amount that the Treasury can borrow.

Rational expectations hypothesis

In 1961, economist John Muth introduced the idea of rational expectations which says that rational economic agents optimally utilize all available information, including past experiences, to form future expectations. This theory and its variants are commonly used in anticipating the behavior of macroeconomic variables like inflation, interest rates and stock prices. Remember how stocks in certain industries skyrocketed when the results of the 2020 U.S. presidential elections were announced? Given the Democrat’s focus on the infrastructure and legalization of marijuana, rational investors factored in the anticipated earnings boost that companies in these industries would experience even though it would take years, driving the price up.