Tuesday, September 26, 2023

How Student Loan Cancellation Could Affect Inflation?

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After months of uncertainty, the Biden administration officially announced on Wednesday that it will cancel up to $20,000 in student loans for many borrowers. Supporters saw the move as a victory that would help ease the burden of student loans for millions of people, including many of the most needy borrowers. But it has also been criticized, including from economists who argue that loan forgiveness could exacerbate inflation at a time when prices are rapidly rising.

Larry Summers, former Secretary of the Treasury under President Bill Clinton, said on Twitter that debt relief for student loans “raises demand and raises inflation.” Jason Furman, an economist at Harvard University and a top economic adviser to the Obama administration, tweeted“It is reckless to pour about half a trillion dollars of gasoline on the inflationary fire that is already burning.”

Conservatives have also attacked the policy, saying it would fuel inflation. Mitch McConnell, the Senate Minority Leader, said the policy would “give even more government money away to elites with higher salaries” rather than help working families struggling to keep up with rising prices.

Many economists say the policy is likely to increase inflation. When people have less student debt to pay off, a portion of their budget is released that they would otherwise spend on their loans. That can make people more likely to buy things like new sofas or cars. And as demand increases and consumers spend more, that drives prices up.

For now, this is still hypothetical. Whether student loan forgiveness ultimately drives up inflation — and if so, by how much — will depend on how people change their spending after their loan balance is reduced or wiped out completely.

Will this exacerbate inflation? It depends on how consumers change their spending.

Much of this depends on how much credit forgiveness actually leads to an increase in consumer spending. The administration said it would cancel $10,000 in student loans per borrower and $20,000 for Pell Grant recipients (borrowers are eligible if their individual income is less than $125,000 or less than $250,000 for married couples). The repayment break was also extended for the last time until the end of the year.

Since the start of the pandemic, no one has had to pay their student loans, meaning payments have been suspended and interest has not accrued, so people won’t see the same immediate budget impact they would have had if they had been obligated to pay.

Michael Pugliese, an economist at Wells Fargo, said he expected the policy to likely have only a marginal effect on inflation, as borrowers don’t actually make money, but rather see an increase in their wealth. People may be inclined to spend more if they receive a check in the mail or if their annual salary increased, he said, but it’s unclear how drastically people would increase their spending if they had fewer student loans to pay off.

Economists at Goldman Sachs and Moody’s Analytics have also predicted that the policy is likely to have a small impact on inflation in the near term. “We would expect the effects on inflation to be equally small,” Goldman Sachs economists wrote in a note Thursday. “However, the end of the payment pause and the resumption of monthly payments seems likely to more than offset the small consumption boost from the debt relief program.”

Pugliese also said it was unclear how much of an impact this would have on the overall US economy, given that the majority of Americans have no student loans (about 43 million Americans have federal debt).

Still, Pugliese said there are many unknowns and it is possible that the policy could have a greater impact on inflation if it significantly increases the spending of those experiencing debt relief. And he said that even a small increase in inflation is not that big, since prices are already up 8.5 percent from a year ago, by some estimates. (The Federal Reserve usually aims for a slower and more stable annual inflation rate of 2 percent.)

“Extra inflation if you’re already so, so high is a lot different than, say, marginal inflation if it’s 1.5 or 2 percent,” he said.

Marc Goldwein, the senior policy director for the Committee on a Responsible Federal Budget, said the government’s student loan cancellation would only put upward pressure on prices as it would lead to higher consumer spending. He noted, however, that it’s unclear to what extent that will happen.

“With an already overheated economy, more spending will actually drive prices up,” Goldwein said. “It’s going to raise prices on everything from clothes to gasoline to furniture to housing because more money is being spent than is being saved in the form of paying off your debt.”

An analysis by the organization, which advocates policies that reduce the deficit, found that debt cancellation and the extension of the repayment pause cost the United States between $440 billion and $600 billion in the next decade. The policy would likely cost more than double the amount saved by the recently passed Inflation Reduction Act, the analysis found.

Some proponents of student debt cancellation argue that the policy would have no impact on inflation. Alí R. Bustamante, the deputy director of the Worker Power and Economic Security program at the progressive Roosevelt Institute, said an increase in wealth won’t lead to much higher spending, as consumers will likely use that money to pay off other debts. to pay. They could also use that money to build their savings, as many households have done during the pandemic, he said.

“So many of these people don’t actually have a significant economic buffer,” Bustamante said. “If you just consider its demographics, you can see that any kind of increase in spending is actually very small.”

Bustamante said the debt cancellation would provide some relief to Americans struggling to cope with inflation, as it puts more money in their pockets and helps narrow the racial wealth gap, as black students are much more likely to take out student loans and borrow larger amounts. . He also said it would help Americans who didn’t finish college but still took out student debt.

But it remains to be seen how the Biden administration’s actions could affect people’s expectations for future debt forgiveness.

Beth Akers, a senior fellow who focuses on higher education economics at the conservative American Enterprise Institute, said that based on recent analysis, the policy would likely have a small impact on overall inflation. But she said she was concerned that students could expect more debt relief in the future, which could boost demand for a university and the amount they are willing to pay. That could then lead to higher education institutions driving up costs due to that increased demand, she said.

“Nobody really knows how strongly students will react to the idea that there might be another cancellation in the future,” Akers said. “So whether this is inflationary specifically for higher education depends on their perception of whether or not this will happen again.”

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