Debt Ceiling Defined: What Is the U.S. National Debt Ceiling?

What Is the Debt Ceiling?

The debt ceiling is the maximum amount of money that the United States can borrow cumulatively by issuing bonds. The debt ceiling was created under the Second Liberty Bond Act of 1917 and is also known as the debt limit or statutory debt limit. If U.S. government national debt levels bump up against the ceiling, the Treasury Department must resort to other extraordinary measures to pay government obligations and expenditures until the ceiling is raised again.

The debt ceiling has been raised or suspended numerous times over the years to avoid the worst-case scenario, which would be a default by the U.S. government on its debt.

Understanding the Debt Ceiling

Congress had free reign over the country's finances before the debt ceiling was created. In 1917, the debt ceiling was created during World War I to make the federal government fiscally responsible. Over time, the debt ceiling has been raised whenever the United States has approached the limit. By hitting the limit and failing to pay interest payments to bondholders, the United States would be in default, lowering its credit rating and increasing the cost of its debt.

There has been controversy over whether the debt ceiling is constitutional. According to the 14th Amendment of the Constitution, "the validity of the public debt of the United States, authorized by law...shall not be questioned." The majority of democratic countries do not have a debt ceiling, making the United States one of the few exceptions.

Advantages and Disadvantages of the Debt Ceiling

Implementing a debt ceiling is practical, allowing the U.S. Treasury to easily issue bonds without having Congress approve it each and every time the federal government needs to raise money—a pretty cumbersome process. With a debt ceiling, the boundaries are in place for a more efficient monetary approval process.

However, the debt ceiling has notoriously been fluid and raised a few times, raising questions on whether it's effective as a tool to ensure fiscal responsibility. The U.S. has reached record-high levels of debt over time.

Debt Ceiling Showdowns and Shutdowns

There have been a number of showdowns over the debt ceiling, some of which have led to government shutdowns. The conflict is usually between the White House and Congress, and the debt ceiling is used as leverage to push budgetary agendas.

For example, in 1995, the Republican members of Congress, whose views were vocalized by then-House Speaker Newt Gingrich, used the threat of refusing to allow an increase in the debt ceiling to negotiate increased government spending cuts.

President Clinton refused to make the cuts, which led to a shutdown of the government. The White House and Congress eventually agreed on a balanced budget with modest spending cuts and tax increases.

Debt Ceiling During the Obama and Trump Administrations

President Obama faced similar issues during his two terms as president. In the 2011 debt ceiling crisis, Republicans in Congress demanded deficit reductions to approve an increase in the debt ceiling. During this time, U.S. Treasury debt was stripped of its triple-A rating by Standard & Poor's—a rating it held for more than 70 years.

In 2013, the government was shut down for 16 days after conservative Republicans attempted to defund the Affordable Care Act (ACA) by leveraging the debt ceiling. An agreement to suspend the debt limit was passed within a day, which was when the Treasury was estimated to run out of money.

The debt ceiling was raised again in 2014, 2015, and early 2017. With U.S. debt exceeding $20 trillion for the first time in September 2017, former President Trump signed a bill extending the debt ceiling to Dec. 8, 2017. The ceiling was later suspended for 13 months as part of a bill enacted in February 2018. The ceiling came into effect and was increased again in March 2019 when U.S. government debt topped $22 trillion.

In August 2019, former President Trump signed the Bipartisan Budget Act of 2019, which suspended the debt ceiling through July 31, 2021. The legislation also lifted spending caps on federal agency budgets, while ensuring that the government could pay its bills in the short term. Suspending the ceiling in this manner eliminated the risk of default for another two years, increasing spending to $320 billion for the 2020 and 2021 fiscal years. The debt ceiling was once again raised to $31.4 trillion in December of 2021.

Newly Appointed House Speaker’s Effect on Debt Ceiling

Some economists and Wall Street analysts believe the recent election of Californian Republican Kevin McCarthy to House Speaker raises the prospect that lawmakers may vote against lifting the debt ceiling later this year, increasing the possibility of the United States defaulting on its debts. 

As part of their support to install McCarthy, conservative faction Republicans have indicated they would vote against raising the debt ceiling without significant federal spending reductions, setting the stage for political gridlock that could destabilize the financial system.

What Happens if the United States Defaults on its Debts?

A default on government debt — which sits at almost $31.5 trillion — would send shockwaves through global financial markets as confidence in U.S. borrowers falls. Credit analysis firm Moody Analytics predicts that a four-month default would shave around 4% from U.S. gross domestic product (GDP), see stock prices fall by a third, and companies slash nearly six million jobs. Furthermore, its analysis reveals that a default on U.S. Treasury bonds could lead to a downturn similar to the 2007 - 2009 Great Recession.

A breakdown in the perceived trustworthiness of U.S. treasuries or credit freeze would almost certainly lead to sharp falls in the Greenback and an exodus of U.S. investments by foreign investors. Even coming close to default has the potential to unnerve financial markets. In 2011, former President Obama and House Republicans narrowly adverted reaching the debt ceiling, which saw stock prices plunge and volatility spike, prompting credit agency S&P Global Ratings to downgrade America's credit rating for the first time. Furthermore, the crisis also dented consumer confidence and small-business optimism,

As well as creating economic uncertainty, a U.S. debt default would impede the government from carrying out critical functions, such as issuing Social Security benefits, maintaining national defense, and adequately funding the public health system.

Yellen’s Warning to Congress

In mid-January 2023, Treasury Secretary Janet Yellen reiterated the importance of Congress raising the debt ceiling to avoid a potential default. “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,” she wrote. “I respectfully urge Congress to act promptly to protect the full faith and credit of the United States,” Yellen added.

A Debt Default Still Remains Unlikely

Despite the ongoing political brinkmanship in Washington over the debt ceiling and spending cuts, it remains unlikely that the United States will default on its debts. President Joe Biden successfully made deals with Republicans in 2021 to pass critical legislation, most notably, the $1.2 trillion infrastructure package. Therefore, it’s likely he will negotiate spending reduction measures with House Republicans in exchange for raising the debt ceiling. Insights and market perspectives site AGF projects a 60% chance of Congress striking an 11th-hour deal to avoid a default, indicating the likelihood of macroeconomic uncertainty in the months ahead.

The Bottom Line

The debt ceiling was created during World War I in order to regulate U.S. government spending and to keep the U.S. government fiscally responsible. Since then, the debt ceiling has been raised or revised 78 times in order to avoid the possibility of default and keep the U.S. economy running, with no signs of Congress turning to other options, despite questions over the debt ceiling's effectiveness.