Three economic consequences of the student loan forgiveness plan

My analysis

Last August, I published an article in The Daily Item on Biden’s debt plan. I tried to leave out my opinions on the process and focus on the facts. Given the Supreme Court’s recent decision, I think it’s worth another look.

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Three economic consequences of the student loan forgiveness plan

Originally Published August 28, 2022

Matthew Rousu

Joe Biden announced this week that $10,000 in student loan debt would be forgiven for many borrowers. The announcement was met with cheers by some and jeers by others and there are certainly debates to be had on the fairness and ethics of this (or any) policy. However, as an economist, I want to focus on three economic consequences from this decision.

First, we need to understand the money to pay for this debt relief must come from someone at some point. There are several options for how this would be paid. One option is this would be paid now by taxpayers. If paid for now by taxpayers, that would mean the policy has some citizens subsidizing other citizens. Those negatively impacted include those who didn’t go to college, those who went to college and have debt but make more than the income limit, or those who had student loan debt but have already paid it off. Another option is it could be paid for by adding to the Federal debt, meaning future generations will pay back this debt and/or pay the interest on this debt. Finally, a third option is the US could increase the money supply, causing higher inflation rates. Of course, there could be a combination of all three of these.

Second, given the current economic state, giving money away will not help the economy. Economists from both sides of the political aisle generally agree that when unemployment rates are high, government actions can help the economy. Given an unemployment rate under four percent, however, there will not be an economy-wide benefit from stimulus payments.

Further, when the unemployment rate is low, stimulus payments like this can cause inflation. We’ve seen evidence of this recently as we now have the highest inflation rate in 40 years and one reason is the increased government spending over the past two years. This new proposed policy will likely exacerbate the issues with inflation. From an economic policy point of view, a policy like this would be more defensible if unemployment rates were high.

Third, this will have long-term consequences on economic behavior. One rule taught in principles of economics classes is that people respond to incentives. By waiving student debt now, students will realize that this type of decision could happen again. The rational response by current students and those who aren’t in college, but with some student loan debt, would be to take out more debt and/or carry that debt a bit longer, with the knowledge that there is a reasonable probability that some or all of it might be forgiven.

This is problematic, however, as maintaining a large debt load is not ideal for those trying to build wealth and this forgiveness program incentivizes people to both obtain more debt and not to pay back debts as quickly.

Overall, this is bad economic policy. It is a stimulus to the economy when the unemployment rate is historically low, threatens higher inflation when the inflation rate is already over 8%, adds to the debt, and encourages future behavior that is harmful.

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Matt Rousu is dean of the Sigmund Weis School of Business at Susquehanna University and author of the book Broadway and Economics: Economic Lessons from Show Tunes. The views do not necessarily represent those of his employer.