As the Treasury debt limit issue intensifies, Moody's Analytics evaluates the potential macroeconomic impact of House Speaker Kevin McCarthy's proposed legislation. If enacted, the "Limit, Save, Grow Act of 2023" could negatively affect near-term economic growth, with real GDP being 0.65 percentage points lower in the year ending in the fourth quarter of 2024 compared to a scenario with a clean debt limit increase.

The legislation aims to increase the debt limit just enough to avoid problems until next year, while significantly cutting discretionary spending, imposing stricter work requirements on low-income assistance, and rolling back Biden administration policies on climate change and student lending.

According to Moody's analysis, real GDP is expected to grow 2.25% with a clean debt limit scenario, compared to 1.6% if McCarthy's legislation becomes law. While both scenarios avoid recession, the timing of government spending cuts in the "Limit, Save, Grow Act" significantly raises the likelihood of a downturn. By the end of 2024, employment is 780,000 jobs lower, and the unemployment rate is 0.36 percentage points higher than in the Clean Debt Limit scenario.

The considerable government spending cuts in McCarthy's legislation create substantial headwinds to near-term economic growth. Nondefense outlays are reduced by $120 billion in fiscal 2024 compared to the Clean Debt Limit scenario, equal to about half a percentage point of GDP. These cuts affect essential government services and lower-income households, who typically spend any government support they receive quickly.

The uncertainty of having to address the debt limit again in a year, especially during a presidential election, exacerbates the economic challenges. However, the legislation's negative impact is partially offset by lower interest rates, as the Federal Reserve begins lowering rates late this year in response to weaker economic growth and heightened recession risks. Nonetheless, Moody's Analytics concludes that the long-term fiscal challenges remain unaddressed, as the legislation does not propose reforms to old-age entitlement programs, which are critical for a sustainable federal budget.

Moody’s analysis was authored by Mark Zandi, chief economist of Moody’s Analytics, and Bernard Yaros, assistant director and economist focused primarily on federal fiscal policy.