No summer hols for European policymakers as spreads again widen

An EU official has been quoted anonymously by Reuters as saying that last year the euro crisis abated once European policymakers retired to their sun loungers and thereby stopped contradicting each other. After another day of seemingly contradictory statements on precisely what last week’s “comprehensive solution” really amounted to, the EU official noted, “that moment can’t come soon enough this year”.

Regrettably for him, it’s already looking like they’ll be denied their relaxation. The cost of insuring Italian and Spanishg government debt against default rose sharply again today after Wolfgang Schaeuble, the German finance minister, sought to address domestic political concerns in Germany by saying that the deal didn’t give the European rescue fund “carte blanche” to buy bonds in the secondary market, but would only take place in “exceptional circumstances”.

Spreads on Spanish and Italian bonds are now back to where they were before last week’s emergency summit. This was partly attributed to worries about the American debt crisis, though quite why this should affect Spanish and Italian bond prices but not unduly concern US ones is indeed a mystery to behold.

In any case, it looks like being a long hot summer, and not one spent on the beach either.

Where the Job Growth Is: At the Low End

There’s more unhappy news for the millions of Americans hoping for a surge in the number of good, high-paying jobs — a new report concludes that the great bulk of new jobs created since the economic recovery began are in lower-wage occupations, paying $13.52 or less an hour.

The report by the National Employment Law Project, a liberal research and advocacy group, found that while 60 percent of the jobs lost during the downturn were in midwage occupations, 73 percent of the jobs added since the recession ended had been in lower-wage occupations, like cashier, stocking clerk or food preparation worker.

According to the report, “The Good Jobs Deficit,” the number of jobs in midwage and high-wage occupations remains significantly below the prerecession peak, while the number of jobs in lower-wage occupations has climbed back close to its former peak.

“During the Great Recession, employment losses occurred across the board, but were concentrated in midwage occupations,” the report said. “But in the weak recovery to date, employment growth has been concentrated in lower-wage occupations, with minimal growth in midwage occupations and net losses in higher-wage occupations.”

The report gives additional ammunition to those who argue, like David Autor, an economics professor at M.I.T., that there is a distinct hollowing out of the middle. It found that the number of jobs in midwage occupations remained 8.4 percent below the prerecession peak, while jobs in higher-wage occupations remained 4.1 percent below and lower-wage jobs were just 0.3 percent below their former peak.

The report divides the nation’s occupations into equal thirds: lower-wage, midwage and higher-wage. It found that during the downturn, the nation lost 3.9 million jobs in midwage occupations, while losing 1.4 million in lower-wage occupations and 1.2 million in higher-wage ones. The report said that of the net employment losses during the recession, 60 percent were in midwage occupations, while 21.3 percent were in lower-wage occupations and 18.7 percent in higher-wage ones.

Since the recession ended, the report said there had been a 1.7 million increase in the number of jobs in low-wage and midwage occupations, with low-wage jobs accounting for nearly three-quarters of that. But the number of jobs in high-wage occupations has declined by 461,994 since the recession ended (from first quarter 2010 to first quarter 2011).

“We should emphasize that it is too early in the recovery to predict whether these trends will continue,” the report said.

The report found that real wages had shown “a mild decline” since the recession began, of 0.6 percent. For workers in lower-wage occupations, median wages fell 2.3 percent after inflation — partly because many of the newer workers hired had lower wages than others in that group. For workers in midwage occupations, wages slipped by 0.9 percent, while there was some good news for workers in higher-wage occupations — their wages rose by 0.9 percent.

The report said the biggest job losses among higher-wage occupations came among managers, computer scientists and systems analysts, human resources workers, registered nurses and accountants and auditors.

The report was written by Annette Bernhardt, policy co-director of the National Employment Law Project. It said lower-wage occupations were those with median hourly ranges of $7.51 to $13.52 an hour (translating to $15,621 to $28,122 a year for a full-time worker), midwage occupations were $13.53 to $20.66 an hour ($28,142 to $42,973 for yearly full time) and high-wage occupations had median hourly ranges of $20.67 to $53.32 ($42,994 to $110,906 for yearly full time).

Growth, real terms growth, and inflation

Click to enlarge

In this figure I show you three things. The red line is the standard rate of annual inflation in the cost of living – the all-items retail prices index. The green line tells us how the real value of quarterly output of the economy compared with the real value of output in the same quarter a year earlier (so, for example, real output in the second three months of 2011 is 0.8 percent higher than real output was in the second three months of 2010). I’ll call this “yearly real GDP growth”. The blue line tells us what happened to quarterly output in cash terms – when there is inflation, a rise in cash terms will be greater than the rise in real terms. I’ll call this “yearly money GDP growth”.

We can see that during most of the period 2000-2006, yearly money GDP growth was usually around 5 per cent, real GDP growth around 2.5 percent, and inflation around 2.5 percent. The first major departure comes in 2006, when money GDP growth goes well above 6 percent. Then inflation goes well above 4 percent (reaching 5 percent). Then we see all three series plummet during the 2008-9 recession. But then look at what happens after the recession. Money GDP growth returns to 5 percent, back to its pre-recession norm. There have been those (most notably Sir Samuel Brittan for many years, and more recently Giles Wilkes) who have argued that monetary policy should target money GDP growth instead of inflation. Indeed, some implicit variant of this is very probably an element in the Monetary Policy Committee’s thinking for 2009 onwards (it certainly was in mine). Well, the period after the recession should make Sir Samuel and the MPC happy – since the year following the commencement of quantitative easing (i.e. in our data, since the second quarter of 2010), yearly money GDP growth has been remarkably stable.

Now, if inflation had been around 2.5 percent, then 5 percent yearly money GDP growth would have meant about 2.5 percent real growth – as many hoped. But, in fact, inflation has been much higher than forecast, so real growth has been correspondingly lower. That extra cash the economy has produced just isn’t worth as much stuff. I suspect that is partly because the capacity for the economy to grow isn’t as high as we’d previously thought.

But now ponder this: what will happen if the economy does start to accelerate? If even the paltry growth of the past nine months has been associated with a rise in inflation, what might be the impact on inflation if the economy really starts to motor? The happy path would be if money GDP growth stayed pretty much where it is, but inflation fell back, so real growth accelerated. That is what the Bank of England hopes will happen. The other possibility is that when real growth accelerates, we will see a larger rise in money GDP growth, so inflation will accelerate even further. That’s what I expect.

Reader Response: The Stigma of Unemployment

I got a lot of interesting responses to my article yesterday about how workers must have a job to get a job. Here is my favorite, from Doug in New York:

This is exactly why I won’t date a women who is not already married. If she’s still single there’s probably a very good reason.

The Auto Industry, Stuck in the Slow Lane

Many of those grasping for a sign of economic optimism these days have pointed to the auto industry. The argument is that as supply chains come back on line following the Japanese earthquake and tsunami, more automobiles will be available for sale to consumers who have been waiting for cars to arrive.

But don’t expect a roaring comeback yet. A report released on Wednesday by AlixPartners, a business consulting firm, projects modest sales growth for the foreseeable future. The report forecasts that United States auto sales will reach 12.7 million units this year, up from the 11.5 million of 2010, but still far below the 16-million-plus that the industry regularly posted in the mid-2000s. AlixPartners forecasts 13.6 million sales in 2013, and does not project that the industry will get back to its peak before the recession “in this current cycle.”

According to the report, several factors are restraining growth in car sales. Unemployment remains high and housing values are depressed, making it difficult for families to tap housing wealth for car purchases. Historically, the report found, one in five vehicles sold has been financed by an appreciation in a car buyer’s home value.

And in a survey of 1,000 Americans by AlixPartners, 83 percent said they had delayed the purchase of a vehicle or planned to wait another year before buying a car.

John Hoffecker, managing director at AlixPartners, said the level of sales before the recession was unsustainable.

“Many people were thinking that was the norm,” Mr. Hoffecker said. “And our view was that it was not actual demand.”

Instead, he said, sales were buoyed by easy financing by carmakers and rapidly appreciating home and stock values. What is more, he said, automakers did not pay enough attention to their cost structures when selling cars, sometimes at a loss.

On the positive side, said Mr. Hoffecker, American automakers have already regained their profits. And future sales will be fueled by population growth in the United States as well as growing demand in developing markets.

The bad news is that the depressed level of auto sales will not help all the laid-off autoworkers get back to work. While engineers and sales representatives have been rehired to levels before the recession, Mr. Hoffecker said, production labor “is not going to come back any time soon.”

Employment of Elderly: Supply or Demand?

Casey B. Mulligan is an economics professor at the University of Chicago.

The supply of elderly workers increased during the recession, and employment rates of the elderly increased along with it. This result is difficult to reconcile with Keynesian characterizations of the labor market.

Today’s Economist

Perspectives from expert contributors.

Last week I showed how employment per capita had increased slightly among elderly people since 2007, while employment per capita in the general population plummeted. I, and other economists previously, have concluded that employment of the elderly deviated so much from the general population because of changes in elderly labor supply.

Perspectives from expert contributors.

Recession-era supply episodes like these are important to identify, because they can prove or undercut Keynesians’ fundamental argument (so far unproved) that supply does not matter during a recession or during a “liquidity trap” such as we’ve experienced since the recession began.

(One Keynesian rhetorical trick is to “prove” the supply claim by pointing to the existence of unemployment. Of course, unemployment exists in large numbers, but that does not tell us whether, and how much, labor supply affects employment rates. Only the latter indicates the value, if any, of Keynesian policy prescriptions.)

In reaction to my post last week, Dean Baker, co-director of the Center for Economic and Policy Research, offered some analysis of weekly earnings and concluded that the demand for elderly workers increased during the recession even while it plummeted for everybody else. Supply played little or no role, he said.

Generally, I agree that wage rates are an important variable for gauging the relative importance of supply and demand (see, for example, my analysis of labor supply during the summer season, which featured hourly wage rates as one of three key indicators). But in this case, Dr. Baker’s weekly earnings results ran into a few contradictions.

First, what was the demand shift experienced by elderly workers that was so large as to completely offset the demand shift purportedly experienced by the rest of the population? Perhaps elderly workers picked up some of the hundreds of thousands of jobs that teenagers and other unskilled workers lost thanks to the minimum wage increases? Dr. Baker did not say.

Second, a huge increase in demand for the elderly might be expected to reduce their unemployment rates, yet the chart below shows how unemployment rates for the elderly followed very much the same time pattern as unemployment rates for the general population. (According to the Census Bureau, every person is either employed, unemployed or not looking for work, which is why unemployment and employment can move in the same direction). Dr. Baker’s purported demand shift is not visible in the unemployment data.

Third, Dr. Baker’s own data suggested that something other than demand was driving most, if not all, of the earnings changes he measured. Elderly employment per capita increased only 4.5 percent. Demand increases by themselves usually increase wage rates about the same amount that they increase employment, which in this case would be well less than 10 percent (for example, during Christmas season, when demand increases employment rates more than it increases wages, not less).

But Dr. Baker measured a weekly earnings increase of at least 17 percent, which tells me that weekly earnings were increasing for reasons other than demand. (This may have been because elderly people were working more hours per week, took on jobs with greater responsibility or because the composition of the elderly work force changed in the direction of greater skill. See this paper for a technical analysis of these forces.)

Labor supply, rather than labor demand, readily explains why elderly unemployment rates tracked the general population’s during the recession, while elderly employment did not: the willingness (or necessity, if you want) of working had changed more for the elderly than for the rest of the population. The fact that labor supply really does matter during recessions means that Keynesian policy prescriptions will not deliver what they promise.

Weak growth may force Chancellor into further austerity

George Osborne on a visit to Brompton Bicycle Ltd (Photo: PA)

Well there’s a thing. Among the list of excuses for another poor set of GDP growth figures are, bizarrely, Olympic ticket sales. May’s ticket sales, which at around £300m are equivalent to 0.1pc of GDP, apparently don’t count as spending until the event actually takes place in the third quarter of next year. But they would have taken money out of people’s pockets which might otherwise have been spent on other things, so there’s a double negative.

In all, the Office for National Statistics estimates that special factors – which it lists as the additional bank holiday for the royal wedding, the royal wedding itself, the after effects of the Great East Japan earthquake, the first phase of Olympic ticket sales, and record warm weather in April – cost approximately 0.5pc points of growth. If this is added back, then the 0.2pc growth announced on Tuesday for the second quarter doesn’t look so bad.

All the same, it’s quite bad enough, and the truth of the matter is that there are always once off special factors battering the economic statistics. They were not obviously more intense in the last quarter than any other. Why not just put the whole economic crisis down to special factors and be done with it?

The bottom line is that you would expect to see some recovery momentum building by this stage of the cycle, and we are not getting it. Indeed, if anything the outlook is worsening, both domestically and internationally. What can the Chancellor do about it? As I wrote in my column for Tuesday’s print edition of the Daily Telegraph, his options are regrettably limited.

There’s little if any scope for significant tax cuts to support the consumer part of the economy, though as I’ve written before, the Chancellor could reasonably indulge in a number of revenue neutral measures that would boost investment such as reversing the higher 50pc tax band and reintroducing taper relief on capital gains.

But big measures, such as a reversal of the VAT increase, would only knock deficit reduction off course, which in today’s febrile financial conditions would be extraordinarily dangerous.

If there is one thing the Government must do, it is maintain its commitment to fiscal austerity. If the deficit isn’t tackled, interest rates will rise, market confidence would be undermined, and future growth would be severely damaged. Britain and many other advanced economies have no option but wear the hair shirt for a prolonged period of time. Any attempt to wriggle out of this corrective adjustment to the excesses of the boom is the path to ruin.

The one positive in all this is that despite the increasingly weak outlook for growth there’s still every chance of the Government meeting its target of eliminating the structural deficit by the end of the parliament. Perhaps surprisingly, this target is quite insensitive to changes in the growth outlook. Even at rates of growth quite a bit lower than the Office for Budget Responsability has been predicting the target ought to be met.

How to explain this apparent paradox? The Government’s fiscal mandate requires “cyclically adjusted current balance by the end of the rolling five year period” (2015-16), in other words, total public sector receipts need to exceed total public sector spending (minus spending on net investment) after adjusting for the temporary effect of any spare capacity in the economy. The Government has supplemented this mandate with a target for public sector net debt as a percentage of GDP to be falling at a fixed date of 2015/16.

It follows that judgements around how much spare capacity there is in the economy – the output gap – will have a big effect on the cyclically adjusted current budget balance by the end of the parliament. The smaller the output gap, the larger the amount of the deficit that is structural and the less margin the Government has against its fiscal mandate. Conversely, if the output gap is wider, less of the deficit is strucutral and the Government has more margin against its mandate.

Well, the OBR has tested its finding that the government stands a high chance of meeting its fiscal mandate against a persistently weak demand scenario, and finds that lo and behold, the Government would still meet the mandate in such circumstances. It is not entirely clear why this is the case, as logically you would expect weaker growth than expected to act as a significant drag on public finance recovery. The best explanation is probably that unemployment has not risen as much as you might expect for such a deep recession, and that the effect on tax receipts and welfare spending of slow growth will therefore not be as damaging as we’ve seen in the past.

In any case, the OBR reckons that the output gap would have to be 1.5pc of GDP lower than assumed for there to be a significant risk to the fiscal mandate and the plan to eradicate the structural deficit. But what if it is lower, as some economists believe? The longer weak growth persists, the more likely it is that there really isn’t much spare capacity in the economy.

Indeed, the idea that capacity may have been permanently destroyed by the recession may itself be false; it may never have been there in the first place. If it turns out that virtually all the above trend growth of the boom was the result of credit and leverage, as seems ever more probable, then the output gap is going to be much lower than officially assumed and possibly even non existent.

In those circumstances, the UK economy really is in trouble. If the structural deficit is much larger than the Chancellor currently assumes, he would be forced into additional austerity measures to close it. If he doesn’t take them, the country’s triple A credit rating would be in jeopardy, as its debt dynamics would look correspondingly worse. More troubling still, he’d have to take such action without being able to rely on compensating monetary action from the Bank of England. To the contrary, the Bank would quite rapidly have to normalise interest rates, whose present highly accommodative disposition is based on the idea that there’s oodles of spare capacity slopping around the economy to soak up any inflationary pressures. Not pretty.

Of Loopholes and Potholes

Nancy Folbre is an economics professor at the University of Massachusetts Amherst.

How can we fill the federal budget hole? The political standoff has been largely defined as a debate over tax hikes versus spending cuts.

Today’s Economist

Perspectives from expert contributors.

Many Democrats want to close tax loopholes in order to increase revenue. Many Republicans believe that government spending should be cut because it hurts the economy, rather than helping it — digging potholes, as it were, rather than fixing them.

Perspectives from expert contributors.

But many tax loopholes for big business are potholes for the rest of us. Closing and filling them would cut spending and improve economic efficiency.

Special provisions in the tax code often provide specific subsidies to distinct groups. Such tax expenditures have the same effect as spending programs.

The word “loophole” implies an opportunity for clever manipulation that leads to unintended results. While some loopholes fit this description, others represent explicit efforts to provide special benefits, reflecting greater political priorities and intense lobbying efforts.

As Senator Russell Long of Louisiana once put it, a tax loophole is “something that benefits the other guy; if it benefits you, it’s tax reform.”

Corporate tax policies in the United States provide significant benefits to shareholders, at considerable cost to everyone else.

Our statutory corporate tax rate, at 35 percent, looks high relative to those of other countries. But the many deductions, credits and other special breaks mean that the effective rate (or taxes actually paid) is much lower — an estimated 13.4 percent of profits over the 2000-5 period, lower than the average for other major industrialized countries.

As my fellow blogger Bruce Bartlett noted, “The United States actually has the lowest corporate tax burden of any of the member nations of the Organization for Economic Cooperation and Development.”

The proliferation of special breaks helps explain why corporate taxes have declined over time as a percentage of gross domestic product and as a percentage of total federal tax revenues.

Robert McIntyre of Citizens for Tax Justice points out that tax expenditures for corporate and other businesses will cost about $364.5 billion in 2011. That’s about a billion dollars a day.

Many special corporate tax breaks also contribute to serious economic inefficiencies.

Corporations that invest overseas rather than within the United States enjoy a huge advantage in the form of deferred taxes on profits. Republican policy makers are now proposing a “tax holiday” or even total elimination of American taxes on offshore profits.

Such policies would further encourage corporations to relocate to countries with the lowest tax rates and avoid contributing to social investments in health, education and environmental protection.

There also is good reason to believe that increased “offshoring” will reduce employment growth.

Some companies, especially those that rely heavily on intellectual property rights like patents, can simply shift their profits to offshore tax havens. Small business owners who cannot easily engage in such practices are rightfully indignant.

Other members of the business community are also speaking out. A Caterpillar executive recently filed suit against his company (the world’s largest construction equipment manufacturer), asserting that he was demoted for criticizing the company’s tax minimization strategy.

Everyone concerned about environmental sustainability should take a close look at corporate tax loopholes. The United States, like most other industrialized countries, continues to provide billions of dollars of special tax subsidies for fossil fuel industries that contribute to global warming.

Nuclear power is also on the dole. Without public subsidies, including limits on economic liability in the event of an accident, it would not be economically viable.

If only we could throw these loopholes into the potholes and have a real discussion of tax reform, instead of getting buried by partisan obsession with the ratio of overall tax increases to spending cuts.

Debt Crises, Real and Fake

There are real debt crises — Greece is going through one — and there are fake ones, created by politicians playing chicken with the nation’s credit.

I expressed that sentiment in a column last week that ran in the Asian editions of The International Herald Tribune on Friday. The new Greek rescue caused me to write a different column for The Times, and the I.H.T. column never made it onto the Web. It follows.

FLOYD NORRIS

Notions on high and low finance.

In the world of government bond markets, never have the haves been treated so much better than the have-nots. The haves can borrow for virtually nothing. The have-nots, if they can borrow at all, must pay exorbitant rates.

Notions on high and low finance.

Yet politicians, even in the countries that investors seem to trust completely, talk of impending budget disaster if spending is not cut immediately.

This summer, as the markets offered a ‘‘no confidence’’ vote on Europe’s effort to rescue Greece — and grew notably more worried about Italy and Spain — they appeared to be highly confident about the debt of the United States government.

The yield on benchmark 10-year Treasury securities fell back below 3 percent this month, even as the Washington rhetoric about the debt ceiling heated up.

That was a sign that investors were not alarmed about a potential United States default, whether in the next few weeks or the next 10 years. If they were, rates would be soaring.

For much of the spring and summer, the proportion of people who believed that Congress would raise the debt ceiling seemed to vary based on the distance from Washington. The closer to Capitol Hill, the more doubt there was that rationality would prevail.

In politics, it appears, familiarity breeds contempt.

If rationality does prevail, the debt ceiling will be raised. For that matter, there is no good reason to have a debt ceiling other than to give politicians a chance to grandstand. The important decisions for Congress and the White House concern spending and taxing. Borrowing, or paying back debt as happened for a couple of years before the Bush tax cuts, is a result of the interplay of those decisions and the state of the economy.

Trying to control the result by putting limits on borrowing is a bit like trying to balance a household budget by waiting until the money has been spent and then deciding not to pay the bills.

To analyze the fiscal problems confronting the United States now, it is necessary not to confuse short-term and long-term problems. And it is crucial to pay attention to the state of the economy.

A weak economy will inevitably worsen the fiscal balance. Tax receipts fall because profits and incomes decline. Government spending increases on automatic stabilizers, like unemployment insurance payments.

To the extent high deficits are a result of a weak economy, a decision to react by cutting spending or raising taxes can lead to a vicious cycle. The solution, if possible, is to revive the economy even if that makes deficits temporarily worse.

One of the most important failures to analyze what was happening in the economy came in the late 1990s, when the United States government, to the surprise of almost everyone, began to run budget surpluses. Some of that was a result of tax increases and spending restraint, but a lot of it was caused by a completely unexpected and misunderstood surge in tax receipts.

That surge was the result of the bull market in stocks, and of the peculiar nature of it. Individual income tax payments soared both because of high capital gains and because profits from stock options are taxed at ordinary income rates, not the reduced rate charged on capital gains.

Most analyses ignored that. The conventional assumption was that the taxes on option profits were balanced by reduced taxes paid by companies. That would have been accurate if the companies were paying taxes and could use the additional deductions. But many of those companies — the heroes of the dot-com bubble — paid no taxes because they had no profits. So the extra deductions did them no good.

A proper analysis would have seen that the inevitable end of the bull market would reduce tax receipts, and a slowdown would increase government spending. In that sense, it is wrong to blame the Bush tax cuts for ending the surpluses of the Clinton years. They would have ended anyway. The deep tax cuts and the wars in Afghanistan and Iraq made the deficits that much larger.

There is a risk that many analysts now are making the opposite mistake. Deficits have skyrocketed in recent years for reasons that are clearly temporary, or that will be temporary if the economy recovers.
In some of the debate, the short-term problems are mixed up with longer-term demographic concerns caused by the aging and retirement of the baby boomers and the rising costs of Medicare, the health insurance program for Americans over the age of 65.

It is worth looking at what has happened to financial markets around the world since the financial crisis exploded. A mild slowdown turned into something much worse after the collapse of Bear Stearns in March 2008 showed the vulnerability of the financial system. Stock markets plunged around the world, credit dried up for many borrowers and there was a flight to safety. Central banks intervened with unprecedented measures and banks were bailed out. Deficits soared.

Now, more than two years later, the American stock market is about where it was in February 2008, just before the crisis hit. That may not sound impressive, but markets in nearly every other country are down sharply. The dollar has lost ground against the Swiss franc and the yen, but is up versus the euro and the pound.

The yields on government bonds — the price investors demand to lend money to the government — are down in countries with solid foundations, including the United States. They have soared in markets where default seems a real possibility, and are up in some European countries where investors are getting more nervous, including Italy and Spain.

That is a vote of confidence in Uncle Sam, at least relative to the alternatives.

Markets can be wrong, of course. But Europe is in far worse shape. Greece is insolvent. It must have its debt reduced, but a default could cause bank failures and substantial losses for the European Central Bank. Europe’s battles reflect the fact that there are no good alternatives. There is a crisis in Europe, where lenders now fear to tread. Would there be one in the United States if the politicians produced an unnecessary default? Let’s hope we will not find out.

On Debt Talks, a Lose-Lose-Lose-Lose Situation

1:07 p.m. | Updated with a fifth (less likely) scenario.

Almost whatever happens this week with Washington’s debt talks, the economy will most likely be worse off.

As Dean Maki, the chief United States economist at Barclays Capital, put it: “The basic issue is that the U.S. is on an unsustainable fiscal track, which is pretty widely agreed upon. From that point, none of the choices are fun.”

CATHERINE RAMPELL

Dollars to doughnuts.

Here are the likely scenarios I see:

Dollars to doughnuts.

1) Held up by disputes over how to reduce deficits, Washington doesn’t raise the debt ceiling in time. As a result, the Treasury stops paying debts it owes.

If that happens, the rating agencies downgrade the United States’ debt. The cost of borrowing for the United States government shoots up, since lenders demand higher interest rates from borrowers that are less trustworthy. Many other interest rates are pegged to the cost for the United States to borrow, making interest rates on all sorts of other loans, like mortgages, rise too. Credit markets freeze up, crushing an already-feeble economic recovery.

Macroeconomic Advisers predicts that failing to raise the debt ceiling in time — even if the delay is only one month — will very likely result in a new recession. And because it’s more expensive for the United States to borrow, the United States debt gets even larger, the exact opposite effect from what fiscal hawks are hoping for.

2) Held up by disputes over how to reduce deficits, Washington doesn’t raise the debt ceiling in time. But rather than default on its debt, it diverts money from other spending into paying back bondholders.

That could mean that Social Security checks are not sent, soldiers in Afghanistan and Iraq are not paid, and all sorts of other consequences.

In addition, bond markets might still freak out because the threat of default remains, so interest rates could rise anyway and cause all the terrible consequences in Scenario No. 1 (potential second recession and even bigger federal debt).

3) Washington comes up with a deal to raise the debt ceiling, but it amounts to less than $4 trillion in savings.

Standard & Poor’s has said that just raising the debt ceiling is not enough; without a “credible” plan for at least $4 trillion in savings, the United States might still have its credit rating downgraded. That could, again, mean higher interest rates and all the other terrible consequences of Scenario No. 1.

4) Washington comes up with a deal to raise the debt ceiling that amounts to more than $4 trillion in savings over a near-term horizon.

The credit rating agencies are appeased, but such severe austerity measures put the fragile economic recovery at risk. The states in particular are anxious about what major spending cuts mean for them and for the many social safety net services they provide with federal support.

As Bruce Bartlett and others have written, similar fiscal tightening during a fragile economy happened in 1937. Those actions resulted in a severe second recession and prolonging of the Great Depression, partly because it was coincident with monetary tightening as well. While a sharp, sudden monetary tightening seems unlikely, the Fed is at the very least pulling back on its easy monetary policy with the end of its second round of quantitative easing.

As The Wall Street Journal’s Kelly Evans observed, Japan had a similar experience in 1998, when austerity measures were followed by a recession and a widespread sell-off of Japanese bonds.

And even if these likely American austerity measures don’t result in an outright recession, job growth is already so feeble that most Americans still think we’re in recession.

Imagine how terrible things would feel if the economy slowed down even further.

5) Washington comes up with a deal to raise the debt ceiling that amounts to more than $4 trillion in savings, but over a longer-term horizon.

This is the best-case scenario: It deals with the long-term unsustainability of the country’s fiscal arrangements — which is good for growth in the long run — but doesn’t rock the boat in the current economic recovery.

Unfortunately, it also seems to be the scenario that is least likely to be pulled off effectively.

Economists want spending cuts and/or tax increases that come after 2012, when the economy is expected to be stronger. But to use Standard & Poor’s lingo, cuts that take effect in 2012 may not be fully “credible.” Committing to future cuts/tax increases is just another way of kicking the can down the road, as Washington has been doing for decades now. Almost every time Congress promises painful fiscal measures at some future date, later politicians jump in to dismantle them just before they take effect.

“We do seem to have a time-consistency problem,” Mr. Maki said. “There does never seem to be a good time for major cuts, and they’re not going to be more popular five years from now versus now.”

He says that Congress must come up with a way to prove that these are cuts that will actually happen, versus something that’s on the drawing board and is therefore erasable.

Unfortunately, he says, “There is no way to completely tie the hands of future legislators.”