How Biden’s Student Debt Plan Will Lower Inflation
A spoonful of forgiveness sugar helps the repayment medicine go down
President Biden is reportedly considering instructing the Department of Education to cancel $10,000 in student loan debt for each borrower (limited to individuals earning under $150,000 and married couples earning under $300,000).
Critics have blasted the plan, arguing that it will exacerbate already record-high inflation. Senator Ted Cruz said it will “drive inflation even higher.” Senator Tim Scott said it will make the “inflation crisis go from bad to worse.” The Cato Institute accused Biden of “trying to increase inflation.”
Those critics aren’t telling the whole story. There’s no need for targeted loan forgiveness to add to inflation. By pairing forgiveness with an end to the COVID pause on loan payments, the net effect of Biden’s plan will be to fight inflation, not add to it.
Congress passed the CARES Act in March 2020 in response to the COVID-19 pandemic. That legislation paused student loan payments without additional interest through September 2020. Subsequently, first the Trump administration, and now the Biden administration, have used executive authority to extend the borrower pause several times.
The latest payment pause extension is due to expire on August 31. However, Biden is widely expected to extend it once more through the end of the year to kick the resumption of repayment until after the midterm elections.
Meanwhile, activists and politicians have been pushing for wholesale debt cancellation. Some liberal Democrats — like Chuck Schumer, Elizabeth Warren, and Alexandria Ocasio-Cortez — have pushed for as much as $50,000 in loan forgiveness for each borrower. (They’ve also led the charge for extending the loan pause in the absence of permanent debt relief.) Biden himself proposed a more limited scope of loan forgiveness during the 2020 campaign, promising “an immediate cancellation of a minimum of $10,000 of student debt per person.”
About 45 million people — about 1 in 5 Americans — owe student loan debt. A third of those borrowers owe less than $10,000; another 20 percent owe less than $20,000. So Biden’s plan to forgive $10,000 would eliminate the debt loan for 15 million borrowers, and halve it for millions more.
On its own, that could have an inflationary impact. But context matters here: right now, almost nobody is making student loan payments. And inflation is a product of the disposable income individuals have to spend. For a borrower with $10,000 in loan debt, Biden’s plan has zero impact on their disposable income: they were not making loan payments this month, and they won’t be making loan payments the month after their debt is forgiven. As National Economic Council director Brian Deese said, the economic effects of loan forgiveness taken by itself will be felt over “years or a couple of decades,” meaning that “the impact on inflation in the near term is likely to be quite small.”
In fact, loan forgiveness could have a deflationary impact if it is combined with an end to the payment pause. And this appears to be exactly what the Biden administration is contemplating: “The White House has assumed any debt forgiveness plan would coincide with the end of a moratorium on all student loan repayments.”
Picture a borrower who currently owes $20,000 in debt. They’ve been enjoying the interest-free payment pause since March 2020. And Biden forgives $10,000 of their debt, while restarting payments. That borrower would see their loan balance cut in half, while also starting to make payments again — payments that would be significantly smaller than what they paid in 2019, but also more than the zero dollars they pay now. So the net effect would be to diminish their disposable income relative to today, and in turn push against rising inflation.
Moreover, the distributional effect of this would actually be progressive, at least within the population of student debtors. Higher-income borrowers would tend to face higher monthly payments than lower-income borrowers, and thereby would shoulder more of the inflation-fighting load. Higher earners tend to hold more student debt than low earners. So low-income borrowers will benefit disproportionately from $10,000 in debt relief (meaning it will on average forgive a larger share of their loans).
At the same time, restarting payments will see higher-income borrowers typically paying a larger amount in absolute dollars each month toward their student loans — because they owe more to begin with, and because $10,000 will make a smaller dent in their balances. And very high-income borrowers won’t be eligible for loan forgiveness at all — so MBAs and corporate lawyers will restart their loan payments with no cancellation benefit. So targeted loan forgiveness + payment resumption is the economic equivalent of a progressive tax that sucks money out of the economy and into DOE coffers disproportionately from the bank accounts of higher earners.
Putting this together, here’s what Biden ought to do: In August, formally announce that borrowers can apply for $10,000 in student debt relief. And to accommodate the application process (which will likely take several months), announce one final payment pause extension through December 31. Some borrowers will start getting their loans forgiven before the midterm elections, boosting Democratic prospects somewhat. And a credible end of the loan pause will lead borrowers to slow down their spending, helping to curtail inflation.
(Where might we see the slowdown effects first? Maybe in the already-softening housing market. Home-buying millennials have had more than two years to take hundreds of dollars each month that would have gone toward student loan payments and put them toward down payments on houses instead. My theory is that this dynamic has served to bid up the housing market. It would follow that restarting student loan payments — in conjunction with rising mortgage interest rates — would let some gas out of the housing market, too.)
It’s also worth noting that the (unfortunate but inevitable) administrative burdens of Biden’s loan forgiveness plan will also diminish any potentially inflationary impact. Means-testing loan forgiveness for six-figure-earners means that borrowers will need to navigate some kind of application process through the Department of Education. The complexity of the process will mean that in all likelihood, fewer than 100 percent of eligible borrowers will successfully get their loans forgiven. That’s bad news for borrowers, but mitigates some of the fear of exacerbating inflation.
Many loan forgiveness advocates are disappointed because Biden is “only” forgiving $10,000, and is imposing cumbersome income cutoffs. But wiping out the full student loan balances of a third of all borrowers, and cutting balances in half for many more, is an objectively big deal. And both the loan pause and Biden’s $10,000 cancellation will become important political precedents. Pausing student loan payments will almost certainly become a go-to form of easy economic stimulus during downturns for future administrations — certainly for Democratic ones, but maybe also for Republicans (remember that Trump initiated this loan pause). And progressive candidates will likely persist in running on more mass student debt cancellation as a general matter.
But disappointed policymakers and advocates should also promote less splashy but important reforms to address student loans and college affordability:
- Lower the upfront cost of public colleges and universities, maybe even by creating a new federally-run college (or network of colleges) that is taxpayer-funded and free of charge.
- Lower interest rates for student loans, such as pegging it to the Federal Reserve’s federal funds rate. Elizabeth Warren had a bill years ago that would have charged student borrowers the same interest rate that the Fed charges to banks — which today would cut student loan interest rates from 5–6% to around 1%, which yields massive savings over a whole repayment cycle.
- Give colleges more skin in the game by docking the financial aid payments and other support they receive from the federal government if they don’t meet quality metrics on affordability, graduation, and student job placement (an idea I pitched years ago).
- Help college students by passing a law requiring that all interns get paid, and by increasing the minimum wage, which would help students working while attending school.
- Achieve universal AP access to close inequities in high school students’ access to Advanced Placement and other college-credit courses that enable them to graduate college earlier with lower tuition costs.
Meanwhile, to inflation hawks, the anti-inflationary piece of Biden’s student debt policy — ending the pause — could be implemented without debt forgiveness. While that’s theoretically true, in the real-world, politics matters. And political realities mean that Biden likely cannot reinstate loan payments without offering some sort of benefit to borrowers.
Payment reinstatement coupled with limited loan forgiveness is the political deal that Biden has to make. And it hits a political sweet spot: fulfilling a campaign pledge, providing benefits to a key Democratic constituency on the eve of the midterms, and acting against inflation in the near term.