NEW YORK (MainStreet) — The damage from the debt ceiling isn't quite over.
Although Washington managed to raise the debt ceiling with an 11th hour deal between Republicans and Democrats, the economy may still be headed towards some harder times. According to researchers, seriously debating whether or not to pay the public debt can cause real, long term harm to the economy.
The problem is all about uncertainty.
Much of the problem concerning the debt ceiling involved this issue of uncertainty, or market confidence. Defaulting on the government's debt, even temporarily, would send the message that America can't be trusted to pay its bills and loans on time. That, in turn, would undermine investors' faith and drive up interest rates on Treasury bonds to compensate for the risk. Since much of the credit market is built on the idea of these bonds as riskless, reliable assets, the damage would have been severe.
Unfortunately, the government doesn't actually need to cross the threshold of non-payment in order to start investor worrying. The mere existence of a serious debate on Capitol Hill is enough to raise red flags on its own.
After all, if the debate sounds sincere enough, this might actually be the time they fail to reach an agreement. It's that kind of fear alone, whether or not America actually does default on its debt, that can ripple throughout the entire economy.
"I think that people were rather uneasy and uncertain about what was going to happen," said Thomas Hungerford, an economist with the Economic Policy Institute. "So this is going to end up affecting consumer confidence and business confidence. It's going to be hard to measure but for individuals or consumers, if their confidence is shaken, they just don't go out and buy things."
Whose confidence wasn't shaken?
According to Steven Davis, professor of international business and economics at the University of Chicago, that impact could be long lasting. Davis and his team have created a measurement called the Economic Policy Uncertainty Index, which quantifies uncertainty in the marketplace brought on by government policy and debates. The index gathers data from a number of sources, including news articles, scheduled changes to the tax code and disagreements about government spending on goods and services.
One consistent result, he says, is that when uncertainty jumps, the pain isn't far behind.
"Increases in the index portend lower investment, lower employment rates and lower economic activity than you otherwise would have forecasted," Davis said. "The peak responses occur about 12 to 18 months after the surprise movements in the policy uncertainty index, so it's a gradual process with the peaks several months later... [But] the weight of the evidence is clearly on the sides of the scale that says higher policy uncertainty is harmful to economic performance."
The most recent debate certainly introduced uncertainty into the market. October of this past year spiked Davis's index to levels only comparable to the aftermath of September 11, the 2008 market crash and during the 2011 debt ceiling debate. In fact, according to Davis, the previous debt ceiling debate created some of the most uncertainty his team has ever measured in the marketplace.
The link between market confidence and on-the-ground employment all comes down to confidence and investment. According to both Hungerford and Davis, greater fear in the economy leads people to begin acting more and more conservatively. Consumers don't spend and businesses wait to invest or hire until they know what's going to happen next. Investors get more gun-shy about bonds that might be just one political battle away from becoming a bad investment. Even when the changes are small, perhaps pushing off that spending by a week or two, when magnified across an entire economy they have a significant impact.
"It seemed like every time it looked like a deal might be coming the stock market went up a little bit, and every time those hopes were dashed it didn't, or it went down," Hungerford said of the recent debt battle. "It was fluctuating, and it was fluctuating in predictable ways."
"If you think about business investment decisions, especially decisions about hiring new workers, those kinds of decisions involve costs," Davis said. "If you're uncertain about whether those investments will pay off, then the natural thing to do is to hold back and wait, wait until either the uncertainty mitigates or you see that the investment will be such a good deal that you're going to go ahead anyway."
Those decisions have a way of snowballing, as workers kept out of work for another month can't spend money, and families waiting to see what will happen next hoard cash just in case. The result puts a drain on the entire economy, one that takes a while to build, but does so nonetheless.
This is just the short term concern. Davis also indicated that the United States might be facing some very long term problems if the debt ceiling fights continue.
"The U.S. is the world's major reserve currency, and the U.S. government borrows trillions at very low rates from the rest of the world," Davis said. "But its always possible that if we raise serious concerns in the minds of foreign investors about whether the U.S. will pay off its loans on time, we'll see less demand for our bonds."
If demand goes down, the Treasury would have to pay more to continue selling those bonds, meaning that interest on the debt would climb. Although this isn't likely in the near future, Davis emphasized that it could become a very real problem someday if these kinds of policy cliffs continue. As other economies grow, currencies like the euro or possibly the Chinese renminbi could become viable competitors against the U.S. dollar and ones that don't come with the risk of volatile policymaking behind them. As a result, the U.S. could lose its access to easy lending and see a spike in the national debt.
In the short term, however, we'll see the impact in jobs.
The debt ceiling fight is over, but the consequences may have just begun.
--Written for MainStreet by Eric Reed, a freelance journalist who writes frequently on the subjects of career and travel. You can read more of his work at his website www.wanderinglawyer.com.