The government is the single largest spender in the economy. So when the government makes a move, it has a large impact on the markets. It’s choice to raise or reduce taxes, increase or decrease the money supply and/or government spending either stimulates or slows down the economy.
In 2011, while Republicans tried to freeze the government’s debt ceiling, the democrats continued to call for a $1.8 trillion increase in order to fund the programs Congress was pushing to pass. The concern at the time was if the debt ceiling was not raised, it could force the government to default. A default is typically a decision not to pay government bondholders back. A default would lead to less movement of monies and securities coupled with higher interest rates which could quiet activity on Wall Street.
According to the New York Times, “If the federal government interrupts payments, whether to Social Security recipients or contractors, those people will then have less money to spend, and the economy will slow down. And if the United States defaults on its debt, there is a risk that the investors could demand a higher interest rate.” In addition, it brings America’s creditworthiness into question in the international market and damages the role of the dollar and Treasury securities in the global market in the long-term.
But failure to raise the debt ceiling could slow the nation’s recovery. But if raising the debt ceiling also means cutting spending, this could slow down the economy’s progress as well.
In July 2011, it was decided the debt ceiling would raise by up to $2.4 trillion in two stages, enough to keep borrowing into 2013. Part of the plan includes cutting spending of $2.4 trillion over ten years. However, many economists are concerned that cutting spending at a time of “economic weakness” might slow down recovery.