It’s time to focus on the House budget negotiations. There are two things that need to be agreed: a government funding bill, by the end of September, and an increase in the debt ceiling, by some time in mid-October. Mr. Obama and Senate Democrats have indicated that they would accept a stopgap funding measures (at current levels) while negotiations continue.

Certain Republicans want to use either or both of these as leverage to defund Obamacare. Since they know that neither the Senate nor the President would likely agree to this, the conversation now seems to be about a delay to parts of the law, in particular the individual mandate. It is unlikely that the Democrats would agree this either, because the individual mandate is an integral part of the healthcare scheme (the only way to keep insurance costs down for the unhealthy is to bring a large number of healthy people into the market) and because any delay would risk giving the Republicans further opportunities to dismember the law.

Let us draw a distinction between Speaker Boehner and his party. The FT reports that Republican leaders are quite frustrated with their more conservative colleagues in the House. Let us take it that Mr. Boehner knows that a government shutdown or, worse, a failure to increase the debt ceiling would be bad for his party, but that he will not be able to take a majority of House Republicans with him if he decided not to threaten either, and might therefore lose his speakership.

First, let’s think about the idea of failing to raise the debt ceiling, on the insistence that Obamacare be defunded or partially postponed. Either of these outcomes would be a loss for the Democrats, so they would probably stick to their guns and allow the debt ceiling to be breached. In that case, the Republicans would suffer damage, but Mr. Boehner would likely keep his position in the short term. Hence, Mr. Boehner would suffer a less-than-total loss, and since this is probably a zero-sum game, Mr. Obama would enjoy a small relative gain. We can use that line of thinking to make some simple payoff diagrams, using 1 to represent a total victory and -1 to represent a total defeat.


Choice:               Defund            Postpone           Fund

Defund               +1/-1              +0.5/-0.5           -1/+1

Postpone              NA                +0.5/-0.5           -1/+1

Fund                     NA                      NA                -1/+1


Choice:               Defund            Postpone             Fund

Defund               +1/-1              +0.5/-0.5          -0.5/+0.5

Postpone              NA                +0.5/-0.5          -0.5/+0.5

Fund                     NA                      NA                  -1/+1

The first diagram shows that the Republicans, as the Calculated Risk blog puts it, are “bluffing into the nuts” — that is, they do not have a winning strategy. The second diagram shows that Mr. Boehner can minimise his losses from this affair by continuing to argue that Obamacare should be defunded or postponed.

The very negative outcomes for the Republican party in the “defund” and “postpone” cases are based on the assumptions that a failure to raise the debt ceiling would be a disaster, and that Republicans would get the blame. These seem plausible. But would a government shutdown be such a disaster, and would the damage to Republicans be as severe? A government shutdown does not imply a US default, after all. Indeed, since it could run on for months, during which the politics could change, the outcome is hard to predict. Let us make some payoff diagrams for this case:


Choice:               Shutdown              Fund

Shutdown               NA                         ?

Fund                        NA                     -1/+1


Choice:                  Shutdown              Fund

Shutdown                 NA                  -0.5/+0.5

Fund                         NA                     -1/+1

Mr. Boehner’s best strategy is, again, intransigence. The difference here is that the Republican party also has a best strategy: shutting down the government. Since there is a possibility that the result of such an action would be something other than total defeat, it is a better strategy than any of those in the first set of diagrams above.

What can we forecast on the basis of this (quick) analysis? That the most likely outcome of the budget negotiations over the coming month or so is that Republicans will agree to raise the debt ceiling but refuse to agree the government funding bill without some modification of Obamacare, leading to a government shutdown.

Of course, there are other possibilities. The most obvious is that House Republicans will not act rationally, and will refuse to raise the debt ceiling. And it is possible, as was the case for the “fiscal cliff” at the end of 2012, that there will be a delay (to which, as noted above, Democrats are already open) that could change the calculus in some unforeseen way.

I note that the Italian government has not yet collapsed. I argued after Mr. Berlusconi’s conviction that such a collapse was unlikely as long as the PDL remained level with, or behind, the PD in the polls. That remains the case (

It makes sense for Mr. Berlusconi to suggest that he could bring down the government: he wants some leverage to persuade the Senate not to eject him (which requires a vote) and to try to secure a presidential pardon. But, if neither of these things comes to pass, it would not be rational for the PDL to bring down the government.

The last time I recommended going short 10-year rates in the US was in the spring of 2011. The yield curve is steepening, and could soon get to the kind of levels we saw back then. Thus a trade could be coming into view. This chart shows the slope of the yield curve between 2Y and 10Y (blue) and between 3M and 10Y (red):


Initial claims 292k b.e. and a large drop to a new weekly post-crisis low.