Debt Limit Policy Questions: What Are the Potential Economic Effects of a Binding Federal Debt Limit?

Federal law prohibits the “face amount of obligations whose principal and interest are guaranteed by the United States Government” from exceeding the statutory debt limit (31 U.S.C. §3101). The Department of the Treasury has the power to take some temporary “extraordinary measures” that extend the date on which the statutory limit is reached. In the event that the federal government reaches the statutory debt limit and exhausts extraordinary measures, the law prohibits Treasury from incurring any additional debt, and Treasury would be required to meet spending demands exclusively through money received from incoming revenues and existing debt. Following a six-month period during which Treasury implemented “extraordinary measures” to prevent a binding debt limit, the debt limit was increased by $5.0 trillion, to $41.1 trillion, in July 2025 by P.L. 119-21. How Treasury would respond to a binding debt limit is unclear. Among its options would be delaying payments until it is able to make them in full or making partial payments on time. Some have proposed that Treasury prioritize certain payments over others, though it is unclear whether Treasury has the capability to construct its payment systems to accommodate payment prioritization or if it has the legal authority to pursue that strategy under current law. The practical hurdles may be less significant for principal and interest payments on the national debt, which the government makes through a separate system managed by the Federal Reserve. Lawmakers have introduced legislation that would direct Treasury to prioritize certain payments in the event of a binding debt limit. Financial institutions around the world perceive U.S. Treasury securities to be among the safest assets available. If investors became concerned that Treasury could not make timely and full payments on the federal debt—regardless of whether the United States actually defaults on debt payments—they will likely demand higher interest rates. An increase in interest costs would increase future government outlays and therefore cause the national debt to grow more quickly than it otherwise would. Making partial or late payments on the national debt might also harm economic activity and the global financial system. Many financial institutions hold large amounts of Treasury securities to use as collateral in large transactions, making the perceived safety of those securities fundamental to the functioning of global financial markets and trade. A sudden perception that U.S. Treasury bonds are riskier would make these bonds less valuable, threatening the systems the bonds underpin. A decline in the value of federal bonds would also lead to a loss of wealth for the businesses, households, and foreign entities that hold these bonds. This decline could have unpredictable effects on the domestic and global economy. Cuts to other federal spending might also threaten economic demand in the United States, which may reduce economic activity and increase both the likelihood and magnitude of a recession. The exact scale of this decline would depend on which payments the federal government does not make in full and on time; the duration of the debt limit episode; and the state of the economy and financial system at the time of the missed payments. A binding debt limit would also prevent the federal government from financing stimulus outlays or automatic stabilizers with new debt, leaving fiscal policy less capable of addressing an economic downturn.