The US has just lifted its debt ceiling - but what is it?

US lawmakers averted a crisis by suspending the country’s debt ceiling last week, saving the country from running out of money to pay its bills.

But what exactly is the debt ceiling? And what could happen if it isn’t raised?

Here’s everything you need to know about the US debt ceiling issue.

It’s a self-imposed cap on the total amount of money that the US is authorized to borrow to pay its bills – such as social safety net programmes, interest on the national debt and salaries for government workers and members of the armed forces.

Because the government runs a budget deficit, where it spends more than it raises through taxes and other revenue, it must borrow money. Lots of it.

The current federal debt limit stands close to $31.4 trillion and was close to being reached before the suspension. US Treasury Secretary Janet Yellen said by June, the government could have run out of money to pay its bills.

It is important to note that raising or suspending the debt ceiling simply lets the government pay for things it has already decided to buy – it’s not about authorizing new spending.

According to the Constitution, Congress must authorize borrowing. The debt limit was introduced in 1917 so that the Treasury would not need to ask for permission each time it had to issue debt to pay bills.

No it’s not mandatory and only a handful of countries have introduced one to signal fiscal discipline to their lenders and investors. The US is one of only three countries to set its debt limit as a nominal value – the other two are Denmark and Kenya, although the latter is shifting to a limit as percentage of GDP.

The nominal value debt ceiling does not cause the same political and economic turmoil over the risk of a default in Denmark, as the Danish Parliament intentionally sets the ceiling sufficiently high, such that it will not be crossed, according to the website, Atlantic Council.

The European Union (EU) is the only other Group of Twenty member to have set a debt limit, but it chose a different mechanism in debt as a percentage of GDP. This is to safeguard the stability of the euro currency, even though not all EU members have adopted it.

Under the bloc’s Stability and Growth Pact (SGP) a member’s debt cannot exceed 60% of its GDP. If a member breaches that ceiling, it can face sanctions and penalties – but there are also mechanisms in place for exceptions during severe economic stress.

It is generally acknowledged that a default would have a catastrophic impact on the US economy, which is why lawmakers tend to come to a last-minute agreement.

Social Security recipients, members of the military, families with children, Medicare providers and holders of Treasury securities would likely not get paid. There could be a partial government shutdown.

Failure to pay bondholders would prompt credit rating agencies to downgrade Treasury debt – meaning the government would be seen as being less creditworthy – leading to higher borrowing costs for the government, businesses and households.

The US economy “would quickly shift into reverse, with the depth of the losses a function of how long the breach lasted,” according to the Council of Economic Advisers, part of the White House. “A protracted default would likely lead to severe damage to the economy, with job growth swinging from its current pace of robust gains to losses numbering in the millions.”

Even without this issue, the US economic outlook is somewhat uncertain. According to the World Economic Forum’s latest Chief Economists Outlook, the respondents are now “evenly split on the outlook for the United States,” with half of them expecting moderate or strong growth and the other half expecting weak or very weak growth. “The country’s prospects have been somewhat clouded recently by heightened uncertainty around financial stability and the pace and extent of monetary tightening,” the report said.

With the US economy still the largest economy in the world, a default-induced recession would spill over into the global economy, which has already been weakened by soaring inflation, the war in Ukraine and the after-effects of COVID-19.

Although the US has come close to a default in 2011, there is no precedent, since the consequences have always been deemed too catastrophic not to force an 11th-hour deal.

A technical debt limit was reached in January, and since then the Treasury Department has been using “extraordinary measures” to continue paying the bills.

These measures are essentially fiscal accounting tools that curb certain government investments so that the bills continue to be paid. But those options are close to being exhausted.

There are some options mooted but they are untested: the Treasury could try to prioritize payments, such as paying bondholders first to avoid a market default, or the Federal Reserve could theoretically buy the debt.