There is mounting evidence that the escalation of student debt in the United States is an impediment to both household financial stability and aggregate consumption and investment. The increasing demand for college credentials coupled with rising costs of attendance have led more students than ever before to take on student loans, with higher average balances. This debt burden reduces household disposable income and consumption and investment opportunities, with spillover effects across the economy. At the same time, the social benefits of investment in higher education—including human capital accumulation, social mobility, and the greater tax revenues and social contributions that flow from a highly productive population—remain central to the economic advantages enjoyed by the United States. In this context, students, educators, and policymakers have called for a range of solutions to the rising cost of college and the encumbrance of borrowers. In this report, we examine the macroeconomic effects of one of the boldest of these proposals: a program of outright student debt cancellation financed
by the federal government. If student debt is indeed dampening household economic activity, we expect liberation from this debt to produce a stimulus effect that will partially offset the cost of the program. In fact, we find that cancelling student debt would have a meaningful stimulus effect, particularly in the first five years, characterized by greater economic activity as measured by GDP and employment, with only moderate effects on the federal budget deficit, interest rates, and inflation over the forecast horizon. Overall, the macroeconomic consequences of student debt cancellation demonstrate that a reorientation of US higher education policy can include ambitious policy proposals like a total cancellation of all outstanding student loan debt.
Higher education is a valuable social investment, with research demonstrating social returns up to five times the dollar amount of public spending in the United States (OECD 2015). The diffusion of these benefits across the economy makes them a classic example of positive externalities, a condition in which individual cost/benefit calculations that omit social benefits will result in a market failure. In these cases, public investment is necessary to avoid chronic underinvestment. Yet in the United States over the past three decades, public funding of higher education has been in decline (SHEEO 2015). At the same time, the increasing need for a college credential to access key labor market entry positions provided incentives for more students to take on debt. This student loan debt imposes a significantly higher burden on household finances than ever before, as stagnant real incomes and higher average balances combine to divert a larger portion of household resources toward debt service and away from consumption and investment.
It is possible for the federal government to reduce
It is possible for the federal government to reduce or remove the burden of student loan debt as a means of direct support to household spending. In this report, we examine the mechanisms that facilitate debt cancellation using T-accounts to map the transactions associated with the program. In a governmentfinanced cancellation program, the current loan portfolio of the Department of Education is cancelled and the federal government either purchases and cancels or takes over the payments for privately owned loans. One of the more significant takeaways here is the realization that, because the loans made by the Department of Education—which make up the vast majority of student loans outstanding—were already funded when the loans were originated, the new costs of cancelling these loans are limited to the interest payments on the securities issued at that time. An alternative route, which some have advocated, involves the Federal Reserve buying up student loan debt and warehousing the losses on its own balance sheet. We consider this option below, noting that this avenue would most likely require authorization from Congress. Importantly, we also show that any program led by the Federal Reserve results in the same consequences for the federal government’s budget position as a governmentled program—that is, there is no “free lunch” that avoids the budgetary implications of cancelling student debt.