First, Tyler uses his extraordinarily powerful mind to concoct a scenario in which the economy collapses from the debt standoff:
As the evening of October 16th approaches, John Boehner is preparing to invoke the Hastert Rule when a car accident intervenes and he is temporarily out of commission. Coordination collapses and some Republicans believe that on the 17th debt payments can continue while some other federal obligations are violated instead. A combination of insufficient payment prioritization (for bizarre technical reasons) and angry Social Security voters, who irrationally fear missing their deposits, means that some payments are in fact missed on Treasury securities….Interest rates skyrocket and there are numerous collateral calls from clearinghouses and thus a squeeze on Treasuries. Everyone is scrambling after Treasuries and suddenly T-Bill liquidity is quite scarce….
By mid-morning of the 17th the payments system has shut down entirely. The Fed tries everything possible, but even with a flood of monetary liquidity, T-Bills are “not what they used to be” and no flow of reserves can make up for this. The monetary authority cannot become the fiscal authority in the span of an hour or a day, especially when it doesn’t have a fully credible fiscal authority behind it. The payments system remains gridlocked. Elsewhere, the Italian 10-year rate shoots over eleven percent, so the ECB has to invoke Outright Monetary Transactions, but the Germans get nervous and don’t go whole hog with this program. A lot of European credit markets shut down too. A major clearinghouse is nationalized.
A full sorting out of the payments mess takes months. In the meantime gdp has shed five or ten percent and borrowing costs are permanently higher. Credit stays slow and the United States enters another major recession. Scott Sumner issues a call for higher nominal gdp.
And in addition to the Sumner jab, Tyler tops it off with a Krugman Kontradiction:
Addendum: By the way, we used to read that an attack of the bond market vigilantes would be good for the economy, but it seems this is no longer the case when the vigilantes are led by Republicans. Hint: an attack of the bond market vigilantes is not good for the economy.