Jul 30, 2022

Would Student Loan Forgiveness Make Inflation Worse?

Everyone has been thinking about student loan forgiveness lately, especially millennials who have student loan debt. Will this make inflation worse? Let's get into it.

Would Student Loan Forgiveness Make Inflation Worse?

Everyone has been thinking about student loan forgiveness lately, especially millennials who have student loan debt. You want to get rid of that, of course. Everyone is therefore pondering the question, "Will that genuinely make my situation worse?"

There's a good argument for it. Inflation will worsen your situation.

In other words, it's more likely that we'll fuel an already-burning fire the more money we produce or the Federal Reserve prints. Many are intensifying their calls for the cancellation of student loan debt before the current payments moratorium expires on August 31. And as you may already be aware, it is currently the subject of lively discussions in the US.

Now, you could anticipate an increase in inflation of 10 to 50 basis points (0.1 to 0.5 percentage points) in the year following the start of payments if the federal government were to cancel all of the $1.6 trillion in student loan debt. This would suggest a rise of between 4% and 20% over the median inflation rate anticipated by the Federal Reserve. To pay off the entire national debt, the federal government would need to spend around $1.6 trillion, but the effect on individual people' financial situations would be similar. When wealth is taken into account, this would lead to a $70 to $95 billion increase in household consumption once the first year's repayments are reduced by $80 billion.

A rise in consumption is often followed by an increase in economic output.

In view of rising disposable income, strong balance sheets, residual supply constraints, and other considerations, the economy is currently unable to meet existing demand in the current climate.  As a result of this, inflation has just reached a record level, which may lead to higher prices rather than increased output in the future. And if the economy continues to grow at a rapid pace and 90% of new consumption leads to price increases rather than output increases, the estimate that canceling all outstanding student debt would increase personal consumption expenditure (PCE) inflation by 37 to 50 (see chart below) basis points (0.37 to 0.5 percentage points) in the year after debt repayments are scheduled to resume. Student loan cancellation would raise inflation by 10 to 14 basis (see chart below) points even if only a third of increased consumption passes into prices and the Fed responds with additional tightening.

Importantly, none of these projections take into account the potential impact on tuition prices of a widespread cancellation of student debt. It's possible that if prospective students know that they can count on more debt cancellations in the future, it will make them more eager to take on more debt, lowering their sensitivity to price increases at schools.

Source: Committee for a Responsible Federal Budget

Due to the fact that repayments are spaced out over a lengthy period of time and that the benefits mostly benefit those with higher incomes, who typically save more money, debt cancellation would have little effect on inflation. But compared to the underlying inflation rate, it's still a significant increase. It would represent a 4% to 20% increase over the Fed's most recent estimate of inflation and a 5% to 25% increase above its target. If inflationary pressures even somewhat increase, a wage-price spiral is more likely, and the Federal Reserve will find it more difficult to adjust inflation expectations to match its current target.

My take:

As you know, the three to seven trillion dollars that were printed under COVID have resulted in tremendous inflation. And in my opinion, adding an extra trillion to that is just going to really expedite an already problematic situation. Considering the conflict in Ukraine, which, in case you didn't know, is home to some of the world's largest grain producers and largest producers of fertilizer and oil, you now have three potential inflation-inducing scenarios. There will be a rise in gas prices and transportation expenses as a result of rising oil prices, and retailers like Target and Walmart are only going to be able to bear that burden for so long before passing it on to their customers.

Oil and gasoline prices are already rising, contributing to inflation. The depletion of food supplies and the subsequent increase in food costs will trigger inflation. Reduced availability of fertilizer means poorer crop yields. A worsening of inflationary pressures is to be expected. Efforts by the Federal Reserve will have to be increased significantly.

The Bottom Line On Student Loans and Inflation:

It will be nearly impossible to control inflation by randomly waiving $2 trillion in student loan debt. And having your purchasing power reduced by inflation is far worse than having to spend more money because you're in debt.

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