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Debt Ceiling Fight Is Damaging Distraction

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The debt ceiling is attracting a lot more attention, especially after President Donald Trump labeled it a “mess” on Wednesday amid growing tensions within the Republican Party. We should expect the rhetoric to get even more heated in the days and weeks ahead.

It is unlikely, however, that this will lead to a technical default by the U.S. or a repeat of the 2013 government shutdown. Instead, the most likely outcome would involve a last-minute compromise that, while it would avoid immediate damage, is likely to add to the delays in implementing the economic measures that are critically needed to deliver higher and more inclusive economic growth.

(Related: Republicans Won’t Stop Fighting With Each Other

Even though it has occurred 74 times in the last 55 years, the lifting of the debt ceiling has sometimes turned into a high-stakes political drama. In addition to bringing to the surface longstanding differences of opinion about the size of government and the dangers of debt, the process is complicated this time by the link to the financing of the president’s controversial border wall. Moreover, differences over the whether, how and when of congressional approval — and Trump has already tweeted that a timely opportunity has been missed by the Republican leadership on Capitol Hill — are now playing straight into the worsening state of political posturing, blame games, and even more complicated and unpredictable games of chicken.

While a political accident is possible, the most likely outcome is that the administration and Congress will agree to an increase in the debt ceiling before the government runs out of financing flexibility at the end of September or the beginning of October. And for a simple reason.

When push comes to shove, neither political party will wish to be associated with a highly embarrassing downgrade of the U.S. sovereign credit rating, an unprecedented technical default for the issuer of the global reserve currency, and a highly unpopular government shutdown. This is particularly true for the Republican Party, which has majorities in both houses of Congress, and has yet to bounce back from failure to deliver on an often-repeated promise to repeal and replace the Affordable Care Act.

Yet the political course is far from clear for the economy and markets. There is a meaningful risk that the escalating tensions over the debt ceiling could provide more than just another short-term distraction for politicians who are already behind in implementing pro-growth economic measures. Instead, the broken glass could end up hampering subsequent agreement on the elements of tax reform, where the list of winners and losers can be devilishly divisive if the process is mishandled. As for infrastructure, where there is more agreement in principle, politicians of the two parties might not wish to be seen collaborating ahead of next year’s midterm elections. And remember, these measures would be just the foundation of a much-needed and broader policy revamp aimed at enhancing actual growth, while also resisting the longer-term structural downward pressures on potential growth. 

— Read Who’s Driving Fed Policy? Most Voting Seats Are Empty on ThinkAdvisor.

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