Another Insane Debt Ceiling Showdown?

Remember last year’s debt ceiling debate? Congress finally raised the ceiling, but our growing government may hit the new limit before the year is over. When Speaker of the House John Boehner said Republicans will fight for spending cuts this time, too, there were immediate outcries of hypocrisy.

As @ObsoleteDogma paraphrased: “Regulatory uncertainty is bad. But default uncertainty is good.” Many also find it ironic that the Republicans are setting up for another showdown even as they are trying to undo the results of the last showdown. (The last deal set up some defense cuts, among other things, but Republicans are now trying to override them.) Others wonder why the GOP even pretends to really care about deficits since they raised a fuss about “$535 mln Solyndra loan guarantee, but just voted to expand a $140B corporate welfare bank.”

The established economist view is that the US should not at all be restricting its borrowing as it tries to spend its way to a recovery that will get enough people off assistance programs and generate enough tax revenues to finally start worrying about the deficit later (nevermind that some of that spending just gets wasted). That’s why economist Justin Wolfers says “Boehner is nuts. The House Republicans are nuts. Congress is nuts. The idea of a debt ceiling is nuts. Nuts nuts nuts.”

But just because Boehner and his posse may be typical hypocritical politicians whose principles flow with the whims of lobbying desires and voter demands, that doesn’t mean that resisting a debt ceiling increase is “insane,” as the usually non-committal Tyler Cowen tweeted this morning.

The pundits and economists are worried that a drawn-out debt ceiling fight could cause a terrible financial collapse, or at least cause severe damage that is completely avoidable. But they seem to be missing the fact that deficit hawks are worried about a different future collapse if investors lose appetite for US Treasury bonds and the nation becomes insolvent.

If you believe, as many conservatives and libertarians do, that there’s a very high chance of a future collapse if we don’t begin to trim our deficit, and that such a collapse would be very bad, then it’s no longer “nuts” or “insane” to press for spending cuts on a debt ceiling deal (especially if you also don’t believe the Keynesians that the spending will help the economy grow faster to trim the deficit faster in the future.) In fact, resisting an easy debt ceiling increase is the only rational course of action if you believe that the following is true:

the probability of a collapse from a debt ceiling showdown * the cost of collapse from a debt ceiling showdown < the probability of a future collapse from insolvency * the cost of collapse from insolvency

Now that certainly may not be true. Maybe there’s not a large chance of future insolvency right now (although given the speed with which interest rates can rise, I’m skeptical at best that you can very certain it can’t be large). Maybe the costs of a debt ceiling showdown would be very high (although the last one didn’t seem to cause any harm, and despite the dire warnings that investors might lose confidence in Treasury bonds, their interest rates are still lower than they were before the showdown; all that hyperpartisan polarization hasn’t made us less attractive than teetering Europe).

I guess my main point is that there’s a lot of uncertainty regarding the costs of limiting (or threatening to limit) the US government’s borrowing now as well as the costs of the US being forced to limit its borrowing sometime in the future, and your bias about government plays a big role in your assumptions about the the probabilities and costs which lead to your opinion about whether another debt ceiling showdown is “nuts” or necessary. As someone biased towards the latter, I’m almost looking forward to it.