Will student loan forgiveness be inflationary?
No. Also, yes.
Let me clarify — in the short run, I doubt the proposed Biden policy will be inflationary.
How is that possible? Aren’t people getting extra money?
No. Well, not exactly. To be clear, no one is getting a $10,000 check so this is not like the stimulus payments received during the pandemic.
I think Biden’s announcement about the end of the repayment pause will actually be disinflationary. In other words, I think it could make prices rise more slowly than they are now (a.k.a. lower inflation rate). Why? Because people have not been making federal student loan payments for more than two (and almost three) years! When payments restart in 2023 — even if people have a total balance that is lower by $10,000 — they are still going to have to make some sort of payment.1 This means they go from paying $0 to paying something more than $0. That should reduce current spending and bring the inflation rate down.
What about future inflation?
It will likely be higher, but it’s hard to tell by how much.
Why will future inflation be higher? First, because people will pay off debt quicker. Lower principal means lower interest costs, which combine for a faster repayment. Second, to the extent that people plan ahead, there will certainly be some people that start increasing spending prior to their loan being repaid and this is spending that would not happen without loan forgiveness. This generates higher demand for stuff, which means higher prices.2 It’s possible that government spending decreases, taxes increase, and/or the Fed raises interest rates to offset any inflationary effects, but I’m skeptical — especially about the first two options.
You certainly can’t be worried about higher taxes and higher inflation simultaneously.
I think it’s hard to dislike this policy solely on grounds that you think it will be inflationary.
Does this mean it’s a good policy idea?
That depends on who you ask. Biden’s political advisors obviously think it’s a good idea. Of course, there are many other important angles you can take. To me, two important and unresolved questions are:
What problem is this solving?
Why is this policy the right way to solve it?
Question 1: What problem is this solving?
On the first one, it’s hard to tell. From the President, himself:
Ok, but why are student loans different than, say, credit card debt? Or mortgage debt? For starters, it’s typically much harder to discharge student loans in bankruptcy and filing bankruptcy in itself is a cumbersome ordeal. In fact, many people aren’t even aware that you can have student debt removed through bankruptcy proceedings. The government knows this and I guess they are working on it, but it represents a significant hurdle compared to other types of debt. Any changes to the process could take a long time to work out the details.
The process of receiving student loans and fully understanding how much you will owe when you graduate is confusing to many people. You are also trying to forecast what type of job you will have and how much money you will be making in the future. Additionally, you have no control over the type of economy you graduate into or if you encounter some type of medical hardship through no fault of your own. Remember, you can’t escape student loan debt as easily as other debt. This can lead to people taking on debt they either aren’t prepared for or that debt turning into something unmanageable for reasons outside this person’s control.
To this, you could basically say two things: “tough luck” or “that’s not fair.”
Biden, and Democrats more broadly, seem to believe the latter. To that end, they’ve already forgiven the debt some students had from predatory, private for-profit institutions. This extends that support more broadly, while trying to target low(ish)-income households.
So, the answer to “what problem is this solving” appears to be “debt that we don’t think is fair.” Ok, I understand and am sympathetic to that perspective. If your instinct when you heard the news about loan forgiveness was some version of “I don’t like this policy because I won’t benefit” or “I don’t like this policy because I had to suffer and everyone else should too” then I don’t really know what to tell you. That sounds like a miserable way to go through life.
Your response might be “but there are so many other things we could spend that money on!” You’re right! That’s called opportunity cost (shout out to the #Econ folks reading this). If you think this deficit spending could/should be used in other ways, then that is a reasonable position to hold. You simply rank other priorities higher.
You may argue that any debt relief should be targeted to those who need it most. The policy in its current form doesn’t seem to do that. Giving relief to anyone with a federal student loan who makes less than $125,000 seems…generous.3 Why not set a lower income cap? Or, why not limit relief to those who took out loans but were unable to finish earning their degree? Giving debt relief to people with college degrees and a six-figure salary makes it much more difficult to claim you are on the side of average hard-working American taxpayer.
Question 2: Is this the right policy to solve the student debt issue?
The second question is much harder to answer. Is this the right policy to solve the debt issue? My gut instinct says no. This just seems like a small bandage on a large wound. It might temporarily slow the bleeding but it doesn’t address any of the underlying causes. Why do people have so much debt in first place? Sure, universities and colleges probably bear some of the blame here but the government sets the criteria for who can get a loan and how much. If people are graduating with too much debt, then perhaps these criteria need to be revisited.4 Biden's plan caps the percentage of income you have to repay each month at 5% but this doesn't address the core issue. Rather, it lengthens the time someone has to pay loans into the future (albeit at a lower monthly rate). While that makes it more affordable early on, it doesn’t address the underlying accumulation of debt. Unless I missed it, I didn’t see anything about lowering the interest rate caps. Currently, undergraduate loans are capped at 8.25% and graduate loans are capped at 9.5%.5 Even in today's higher inflation environment that seems excessive to me. I think an essential component of any strategy to seriously tackle student debt has to start with the interest rates students are being charged. There is a provision to reduce some of the interest accumulation:
“Cover the borrower’s unpaid monthly interest, so that unlike other existing income-driven repayment plans, no borrower’s loan balance will grow as long as they make their monthly payments—even when that monthly payment is $0 because their income is low.”
This is a step in the right direction but there is much work left to do.
The price of a college education also seems to be at the core of the issue. Please understand this: when you make loans for college larger and easier to get, you are causing the price of tuition to rise. There is nothing in the plan but vague overtures at making sure students are getting their money’s worth. It’s hard to see how this plan will substantively reduce the debt of future students. In other words, this seems to set up a precedent for dealing with a problem that is likely to persist well into the future.
Takeaways (without the BS)
If you are worried about near-term inflationary consequences of student loan debt relief, then stop. Inflation is more likely to come down over the next few years than rise.
Even if you think student loan debt is an urgent problem, there are many questions about whether this is the best way to go about it.
Other interesting questions you should be asking:
Is this a good use of executive power (assuming it withstands legal challenges)?
To what extent should we be worried about moral hazard problems? In other words, do people expect this to be a one-time thing, or something that future politicians also push for?
Why did they pick $125,000 as a cap if 90% of the benefit supposedly goes to people making under $75,000? Why not just make that the cap? Or $50,000? or $150,000?
How might this affect future tuition prices?
Of course, if their total balance was $10,000 or less, then they no longer have to make payments. That doesn’t really affect the logic here, though. Total spending on repayments will be more than it has been over the last two years.
You could try to argue that supply would also expand, but don’t confuse a shift in supply with a movement along the supply curve. This scenario is the latter. Also, I would argue this will be more of a gradual level shift in prices, rather than something that fuels a permanent increase in the rate of change in prices.
Note that this policy only applies to federal student loans. So, if you have a private loan then you will not qualify. If you had federal student loans at one time, but then refinanced them later to get a lower interest rate you also don’t qualify (because you now have a private loan).
Yes, this will reduce access to higher education. No, I don’t like that idea.