Forgiving Student Debt Isn’t a Great Stimulus Plan

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As President, Joe Biden will face an uphill battle to resuscitate the U.S. economy. If the Senate remains in Republican hands, he'll be forced to rely on the limited powers of executive action. Forgiving student debt is one potential action Biden allies are already discussing . But while this would be a good policy in many ways, it probably wouldn't be a highly effective fiscal stimulus.

The U.S. has a lot of student loans. Since the Great Recession, education-related debt has surpassed that of autos and credit cards:

Forgiving Student Debt Isn’t a Great Stimulus Plan

This overhang of debt has pernicious long-term economic effects. The need to keep making loan payments every month ties college graduates to their current jobs, making it riskier and more difficult to start a business or go looking for a better position. That makes the whole economy less dynamic. A large-scale student-debt forgiveness program, coupled with a future shift toward income-based repayment schemes for college educations, would make the economy more dynamic in the long run.

And it’s within the government’s power to do this, because most student loans are now owned by the federal government:

Forgiving Student Debt Isn’t a Great Stimulus Plan

It’s an open question whether the President could forgive this debt without an act of Congress. Some legal scholars believe that if various executive agencies acted in concert, they could simply stop collecting the debt forever, meaning that it would be effectively cancelled.

Whether this makes for good politics is another question. Canceling student debt might provoke a backlash among those who don’t have any loans. People who decided not to go to college because it was too expensive might be upset at a government action that invalidates their decision. Those who paid off their loans early might feel that their frugality was being punished. Parents who forked over more cash for their children’s educations to help those kids avoid the burden of debt might be similarly incensed.

There’s also a moral hazard to consider. A big cancellation of student debt might convince people that such forgiveness would become a regular occurrence. That would make students more willing to take on debt, which would compound the problem in the future and push up tuition even further.

One potential solution to that problem is to shift toward income-based repayment plans where students pay little or nothing up front for college, and then pay the university back depending on how much money they make in the future. But that's not something the president can do by executive fiat, and as Australia has discovered, the implementation can be tricky.

Suppose that the legal and political difficulties can be overcome, and the moral hazard is minimized because people understand that debt cancellation was a recession-fighting measure rather than a regular policy. Would student-loan cancellation be an effective fiscal stimulus? Probably not.

First of all, the size of the stimulus would be small in terms of actual monthly dollars. If you cancel $50,000 of someone’s student debt, it doesn’t mean they get a check for $50,000; it simply means that their monthly loan payments go away. Feeling $50,000 richer might make people want to go spend more out of sheer optimism, but this effect, known as a wealth effect, is probably quite small.

To have any appreciable effect, people would need to go out and spend the money they'd have otherwise used to make their monthly loan payments. Would they do so? As Matt Bruenig of the People’s Policy Project, a think tank, points out, student loan holders tend to be higher on the income scale. Higher-income people tend not to live hand to mouth -- if they get a little extra money they’re more likely to save it than spend it.

Those who do go out and spend stimulus money tend to be people who don’t have much liquidity. But Americans have been repaying their debts for years and have built up a decent amount of cash. Thanks to that, and to low interest rates, household debt-service payments are at multi-decade lows:

Forgiving Student Debt Isn’t a Great Stimulus Plan

So canceling student debt probably not going to make American consumers spend much more, and thus would be a very weak stimulus.

Some will argue that a very weak stimulus is better than no stimulus. But given the potential backlash, legal uncertainties, and potential for moral hazard, student debt cancellation by executive fiat might not be worth it at all. While student loan forgiveness and a shift toward income-based repayment would be a good long-term policy for increasing economic dynamism, the kind of executive action now being discussed is no substitute for real stimulus measures.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

©2020 Bloomberg L.P.

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