Bailout

The behavioral case for the debt ceiling

By Felix Salmon

John Carney takes a stab at answering my question about why we have a debt ceiling, saying that it “helps raise public awareness about the costs of government”:

Lawmakers must go on record as approving an increase in the debt limit in order to enable the government to borrow to fund the spending the lawmakers have approved. They must confront, in a very public manner, the costs of the programs they have enacted.

I’m not at all sure this is the actual reason why we have a debt ceiling; at best it’s a behavioral reason not to abolish it. But it’s not a good reason.

Let’s take a personal-finance analogy here. A credit card company comes along and offers you a card with a $200,000 credit limit?much more than you should ever borrow. But you know that if the money is there for the spending, you’ll be more likely to spend it. So you phone up the credit card company and do a deal with them. You set the limit very low?$1,000, say?and then, any time you want to go over that limit, you have to phone up the credit card company and get them to raise it.

You know in advance that the credit card company will say yes: after all, they’ve already told you that as far as they’re concerned they’re happy to lend you $200,000. But being forced to phone them up and ask for a credit-line increase helps to drive home the consequences of your spending decisions, in a way that simply whipping your card out at the Apple Store doesn’t.

So far so good. But what if you were using your card not only to buy iPads, but also to make rent? And what if there were possible glitches with the system whereby you phoned up and asked for a credit-limit increase, so that you couldn’t be sure it would always work? And what if a single late rent payment could be catastrophic, ending up with you thrown out of your home? At that point, your clever system would stop seeming so clever, and start seeming downright risky.

And that’s the problem with the debt ceiling. It might have interesting and possibly even beneficial behavioral second-order effects, although there’s precious little evidence for that. But getting those beneficial effects means playing with fiscal high explosives, which run the risk of blowing up in the economy’s face and causing major damage. It simply isn’t worth it.

Full post as published by Macroprudential on January 12, 2011 (boomark / email).