Debt ceiling deal won't have much impact on the US economy, analysts say

Washington, DC CNN

The President Joe Biden, and the House Republicans, have reached a final agreement to raise the debt ceiling of the government. This includes changes to the federal spending budget in several areas. Analysts claim that the agreement will only have marginal effects on the US economic system.

This is based on estimates that show government spending will only be slightly reduced over the two-year period of the agreement, causing a minimal effect on the overall economic output, as measured by the gross domestic product. It also includes a limited number job losses.

Investors who were worried that the debt ceiling crisis would have had a more significant impact on the economy may be pleased to hear the effects are relatively mild.

Mark Zandi is the chief economist of Moody's Analytics. He told CNN that 'the impacts will be small but negative'. When you add it up, it is a modest headwind for a sluggish economic climate, but it won't be enough to push the economy into recession.

Analysts say that despite the deal's limited impact on macroeconomics, it could usher in an era of more stringent fiscal policy. This is because Congress has to contend with a deficit which grew during the Covid-19 pandemic years.

What's in the deal? And how would it affect the economy as a whole?

What is in the debt ceiling agreement?

The agreement would suspend the federal debt ceiling of $31.4 trillion until January 2025. The deal would maintain non-defense expenditures at a relatively constant level in fiscal 2024, and then cap spending increases to 1% for fiscal 2025. The fiscal year of the US government runs from October to September.

The deal, in addition to cutting spending, would also protect veterans' health benefits, extend temporary work requirements for some adults receiving food aid benefits, clawback some Covid-19 funds, reduce funding for the Internal Revenue Service and restart student loan payments.

The Congressional Budget Office will release a detailed report on the deal sometime this week.

Biden still needs to sign the bill and both chambers of Congress must pass it, but financial markets are already responding positively. Some companies' stocks have even risen. The US House will vote on the agreement Wednesday evening. If the bill is passed, a Senate vote could be held as early as Thursday.

The debt deal with GDP

Goldman Sachs economists estimate that the deal will reduce federal spending in the United States by up to 0.2% per year of gross domestic products over the next two years, compared to their baseline estimate.

Goldman Sachs economists noted in an analyst's note that 'the boost in funding Congress approved for FY23 late last year was so large' (nearly 10 percent year-over-year) that discretionary spending will likely be higher next year in real terms despite the new cap.

Ian Shepherdson said that in a webinar he expected the deal to lower GDP growth by 0.2% in 2024, and 0.1% more in 2025. This is 'well within margins of error for GDP measurement'.

Gregory Daco is the chief economist at EY-Parthenon. He estimated that this proposed deal will have a drag of 0.3% on real GDP by 2024, and result in 250,000 job loss. According to Bureau of Labor Statistics data, the economy had 161 million jobs filled in April.

The financial markets seem to be reassured by the prospect of a deal on a debt ceiling.

'Getting rid of this uncertainty has a real effect on markets and decisions,' said Mike Skordeles. He is the head of US Economics at Truist Advisory Services.

Zandi stated that the resumption in student loan payments, which had been planned before the drama over the debt ceiling, would have a minimal macroeconomic impact as Americans' savings are still healthy and the labor market is holding up so far.

One analyst, however, said that the agreement could mark the start of an austerity era. Austerity is defined as a series of economic policies designed to control debt.

Michael Reynolds, Glenmede's vice president of Investment Strategy, told CNN that the deal was only the beginning of a series that would be taken to reduce interest rates that were increasing as we moved through the 2020s.

Investors will need to accept that the federal government is likely to reduce spending in the future. Even after accounting for this shift, other changes may be in the pipeline which would further reduce spending.