We want to fight inflation and we want to keep the labor market strong. One of the most important ways to achieve both goals is to forgive a portion of student-loan debt. And yesterday, President Joe Biden announced that he was doing just that—canceling up to $10,000 in student debt for those making less than $125,000 and designating an additional $10,000 in loan forgiveness for Pell Grant recipients. Yet critics are attacking the measure, even at its modest level and with its targeted exclusions and benefits, as inflationary and unfair.
Whatever your view of student-debt cancellation, the inflation argument is a red herring and should not influence policy. Taking that logic to the extreme, canceling food stamps would do far more to reduce inflation—but that would be cruel and inhumane, and fortunately, no one has suggested doing so. A closer look at the student-debt-cancellation program suggests that the new student-loan policy may even reduce inflation; at most, its inflationary impact will be minuscule, and the long-term benefits to the economy are likely to be significant.
The contention that debt cancellation will be inflationary contains a series of flaws. To start with, the value of the reduced debt repayments is so small that the cancellation’s impact will be negligible.
Although the broad estimates of the total amount of canceled debt can be big—some reach hundreds of billions of dollars—these figures derive only from budgeting practices for how credit programs like student loans are recorded. The government and budget analysts calculate a number that is known as “the present discounted value of foregone payments.” This corresponds to a current estimated value not of the lost payments this year, but of those in all future years. In other words, this calculation treats all of the losses from debt cancellation as though they occurred right now in a single year (adjusted for inflation)—a far cry from the reality. Such an accounting procedure can be an appropriate practice for thinking about the government’s long-run balance sheet, but it is a very poor guide for understanding what actually happens to people’s spending.
The inflation hawks compound this error by assuming that the indebted students will take their forgiven debt and go on a spending spree, a splurge of such magnitude that they would have to somehow find someone in the private sector willing to lend them the same amount at low interest rates to finance their extravagance. Economic theory says that these individuals will, at most, consider this an increase in their net wealth—I say “at most” because in many cases, these loans would never have been repaid at all. And economic theory also says that an increase in wealth is spent gradually over the course of a person’s life, not all in one year.
The actual amount of annual debt payments that would be reduced now, during this present inflationary episode, will probably run to tens of billions of dollars, not hundreds of billions. The lower number is likely because, again, many of those whose debt is being forgiven would not be making the payments anyway; many people with these debts simply don’t have the economic means to repay them.
The costs of cancellation are also far less than the value to be realized when student-debt payments resume after having been halted during the pandemic. Right now, because of the forbearance put into place in 2020, no payments are being made on government-owned student loans. This policy was essential to stabilize the economy during the pandemic. As part of a larger program of cancellation, the Biden administration would end forbearance; the resumption of payments in January is estimated to be worth more than $30 billion annually.
These numbers are modest relative to the size of our economy. Still, their net effect will be to reduce inflation.
Some of the critics demand that payments should simply resume without any cancellation. That would plunge a large number of student debtors back into immediate financial distress and further loan delinquency. According to analysis from the Federal Reserve Bank of New York, just before the pandemic, 11 percent of student debt was either in default or more than 90 days in arrears. Because of pandemic forbearance and other emergency measures, that default rate went to zero for most student debt—though researchers found that student loans excluded from forbearance continued to default, not surprisingly, at a high rate. According to the New York Fed’s survey, once payments resume, we will quickly return to that world: A large segment of people will be unable to service their payments and, in the Fed’s words, “lower-income, less educated, non-white, female and middle-aged borrowers will struggle more in making minimum payments and in remaining current.”
This level of distress is bad for the economy, both in the short run, as we strive for a robust recovery, and in the long run. Having little or no access to credit means that starting a family or a small business, moving, or otherwise building up lives is much harder for so many young people. A growing body of evidence backs up the common-sense conclusion that student-loan debt is linked to people delaying significant life events such as getting married and having children.
This has society-wide consequences. People’s well-being is obviously affected, and so is the economy. The Federal Reserve Bank of Philadelphia found that student debt is associated with weak new-business formation, in particular of new businesses with one to four employees. Given that the rapid increase in the number of small businesses—especially ones founded by Black and brown entrepreneurs—that we saw in 2021 may already be slowing down, we should be looking for ways to support that growth, not undercut it.
Studies of those student debtors who have had the good fortune to get their debt canceled by courts have found that the freedom from loan payments allows people to borrow anew and move around the country to take better jobs. Because continuing to build up our labor force and help people find jobs better matched to their skills is so important, a comprehensive student-loan debt-cancellation program will have a valuable economic upside.
Until recently, the U.S. led the world with high-quality and widely accessible college education. American prosperity and freedom have been tied to innovations such as the land-grant university, the GI Bill, and our world-class public universities. But because that education now comes at an ever-increasing price accompanied by an ever-increasing student debt for so many, our students fall behind before they even start their first jobs. The entire system of supporting and financing higher education needs an overhaul, but in the interim, we need to understand and address the immediate problem—and the Biden administration yesterday took a crucial first step by reducing the debt burden on many struggling American families.