My operating assumption has long been that the debt ceiling will be raised. The potential cost of a failure to do so is just too large for either party to tolerate. And despite the recent ructions, I still think that an increase in the ceiling is likely. But I think it's fair to say that the odds of some kind of "default", while quite low, have risen a bit.
This could potentially be a problem. Markets try to prepare for trouble. If there's a chance of bad times ahead, market participants will take precautions, just in case. They may move money to safer assets, increase cash holdings, curtail marginal investments, put off hiring, and so on. Do you see the problem? These sensible measures are themselves bad for the economy. Now, the probability of an actual default isn't very high. But the cost of default is catastrophic. So even if the odds of default shift from very small to slightly less small—from say 2% to 5%—that shift represents a substantial increase in the potential economic downside looking forward. And that, in turn, could lead to greater precautionary measures from banks, businesses, and households.
Because failure to raise the debt ceiling would be so nasty, that very possibility could cause serious economic damage even if the odds of an actual default never approach 50%. This, once again, is why Congress should tread extremely cautiously. Its only responsible course of action is to pass an increase in the debt ceiling without any further delay, and certainly without any further dramatics.
