When the Department of Education (ED) was formed in 1867, the goal was simply to make schools more effective and accessible for students. But with the passage of the GI Bill and the National Defense Education Act (NDEA,) the role of the ED expanded and the first federal student loans began to be disbursed. It was not until 1972 that Congress passed the Basic Educational Opportunity Grant, also known as Pell Grant. It was in the early 1990s that the federal government implemented the Federal Direct Loan Program, which allows students to borrow student loans directly from the government rather than going through private institutions. Today, all federal loans are required by law to be direct loans, but private lenders are also able to provide student loans. As of the writing of this article, the outstanding federal student loan debt is $1.76 trillion.
It is worth looking back and asking ourselves why the federal loan and grant programs were established in the first place. The first student loan was provided in 1958 under the NDEA act. This was done as part of the federal government’s effort to create a better-educated labor force to compete against the Soviet Union. The move came after the Soviet Union launched the Sputnik satellite. These first student loans were provided only to a select group of students studying targeted subjects such as science and engineering. However, the implementation of the loan program became more than just a geo-political endeavor. Because of the popularity of these programs, over time, the federal government expanded the loan programs to all fields of study. Part of the reason for this expansion was the recognition that college education provides a significant amount of positive externality to society. Better-educated people provide better economic value to the society; they are more entrepreneurial, pay more taxes, and engage in less criminal activities- all of which provide economic benefits to the community. Therefore, in order to increase the demand for higher education, the federal government implemented federal grant and loan programs with one simple notion- that having more college-educated students equates to more economic activity and better society.
After adjusting for inflation, the student loan debt has increased nine-fold over the last two decades, from $187 billion in 1995 to $1.7 trillion in 2021. So, how did we get to this point and who is to blame for it? If you talk to a baby-boomer, they might argue that they worked hard during the summer months to be able to pay their tuition for the year and therefore graduated college without a single penny of debt. The problem with this argument is that the cost of colleges has increased significantly over the past few decades. According to the National Center for Education Statistics, the average total in-state cost of attending a degree-granting public college has increased over 10 times, from $1,856 in 1980 to over $19,747 in 2020, adjusting for inflation. Several factors, including state funding cuts and increasing demand, are responsible for the dramatic increase in college costs over time.
The huge amount of student loan debt has a significant impact on the economy. In fact, according to a recent survey conducted by bankrate.com, 21% of borrowers have delayed getting married, 26% have pushed back having kids, and 36% have put off buying a home. That translates into a reduced young labor force, a larger aging population, and less economic activity. If this rate of student loan debt continues along the same trend, we are looking at a whole generation of population with less productivity and less wealth who are not able to contribute at their full potential to the country’s economic activity. Most economists fear that this means that we are looking at very bleak economic growth in coming decades. In fact, some data already point to this. According to NPR, the millennials’ net worth is about 11% less than that of the previous generation. The income and wealth disparity between these generations is getting wider. According to data from the Federal Reserve, when baby boomers were under 40, they held 13% of household wealth, compared to just 5.9% for millennials under 40 in 2020, and that gap is expected to increase.
Looking at all these economic implications of student loan debts, it is clear that this huge amount of debt is a problem. So, what can we do about it? One proposal, mostly from Congressional Democrats, is that we should forgive most or all of this debt. However, there are a lot of logistical challenges to this proposal along with some significant economic implications if it is not done right. If all the student loan debt is erased, what happens to the loans held by new borrowers and how do you change the student loan structure for future borrowers? Do the students who have paid their debt get a refund? There has not been a definitive answer to these questions from the ED or the Congressional members. Despite all these logistical challenges, I would argue that we should move towards targeted and incremental debt forgiveness for student borrowers. The future of this generation and the future American exceptionalism depend on it.
According to the Committee for Responsible Federal Budget (CRFB), a blanket $10,000 forgiveness for all borrowers would eliminate debt for 15 million borrowers and boost the GDP by $31 billion over three years. Since these loans are direct loans, it would not add to the federal debt stock. In addition, the current Income Based Repayment (IBR) plan allows for some debt forgiveness for some borrowers after a certain number of payments over several years. Therefore, there are a few actions that the ED can take towards student loan forgiveness: 1) Reform the IBR plans so that the repayment amount and time is shortened. Under the current plan, a borrower who lives in household whose income is $100K has an IBR monthly payment of approximately $550, even if the borrower does not have any personal income. 2) Reform the future loan structure so that new borrowers know the implications of having student debt. 3) Consider forgiving student loans of $10,000 every year, with borrowers having to make monthly payments based on the reformed IBR.
The question, then, is how will these adjustments affect the macroeconomic health of the country? Currently, the unemployment rate is just 3.6%, but the GDP growth rate for the first quarter of 2022 is -1.4%. Because of the newly released data on the growth rate, the general fear of recession (and possibly stagflation) has grown. Therefore, I’d argue that this is a good time to start some form of student loan forgiveness. However, since the fear of inflation is still strong, caution must be used to implement the forgiveness program. An influx of thousands of dollars in the economy as a result of loan forgiveness would create an inflationary pressure by boosting the aggregate demand in the economy. The amount of the inflationary pressure depends on how the student borrowers decide to spend (or save!) the money. The Federal Reserve might have to adjust the money supply to make sure that the inflation does not increase further. Since the core CPI does not include food and energy prices, I’d argue that there will be a very marginal impact in the core CPI as reported by the BLS. According to the Institute for College Access and Success (TICAS,) 65% of the student borrowers who have defaulted on their loans had incomes below 200% of the federal poverty line for their family size. Therefore, we should expect most of the money from forgiven loans would go towards financing basic necessities, such as food and housing, which would not affect the core CPI.
Forgiving the student loan debt in an incremental way as I suggested would amount to be the largest transfer of wealth in American history. However, doing nothing about it could be catastrophic.
|Dr. Robin Dhakal|
Dr. Robin Dhakal Bio:
“Dr. Robin Dhakal is an Assistant Professor in the Forbes School of Business and Technology. He earned a M.A. and a Ph.D. in Economics from University of South Florida and a B.A. in Business/Economics and Mathematics/Computer Science from Warren Wilson College. His academic research focuses on development economics and political economy. He has been teaching Economics in colleges and universities for the past nine years. “
Brief History of Federal Student Loans | NCLC Digital Library. (2017). National Consumer Law Center. https://library.nclc.org/sl/0103-0
Anderson, T. (2015, August 5). Debt-Locked: Student Loans Force Millennials to Delay Life Milestones. NBC News. https://www.nbcnews.com/better/money/debt-locked-student-loans-force-millennials-delay-life-milestones-n404636
Bhutada, G. (2021, February 4). The Rising Cost of College in the U.S. Visual Capitalist. https://www.visualcapitalist.com/rising-cost-of-college-in-u-s/
Gitlen, J. (2022, January 19). The History of Student Loans in a Timeline. LendEDU. https://lendedu.com/blog/history-of-student-loans
Minsky, A. S. (2022, April 21). What The Student Loan Forgiveness Memo Means For Mass Student Debt Cancellation. Forbes. https://www.forbes.com/sites/adamminsky/2021/11/04/what-the-student-loan-forgiveness-memo-means-for-mass-student-debt-cancellation/?sh=3aa0da061efc*The opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of any other entity.