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The Macroeconomic Effects of Student Debt Cancellation THE MACROECONOMIC EFFECTS OF STUDENT DEBT CANCELLATION Scott Fullwiler, Stephanie Kelton, Catherine Ruetschlin, and Marshall Steinbaum February 2018 Levy Economics Institute of Bard College 2 Student Debt Cancellation Report 2018 THE MACROECONOMIC EFFECTS OF STUDENT DEBT CANCELLATION Scott Fullwiler, Stephanie Kelton, Catherine Ruetschlin, and Marshall Steinbaum Levy Economics Institute of Bard College 3 Table of Contents EXECUTIVE SUMMARY 6 INTRODUCTION 7 SECTION 1: THE ECONOMIC OPPORTUNITY OF STUDENT DEBT CANCELLATION 9 Social Investment in Higher Education 9 The current state of student debt 10 The social costs of student debt 12 The Distributional Consequences of Student Debt, Student Debt Cancellation, and Debt-Free College 13 The distribution of student debt and debt burden in the cross section 14 The evolution of the distribution of student debt burdens over time 15 What does the evolution of student debt tell us about the labor market? 16 How does student debt interact with longstanding economic disparaties? 16 The real distributional impact of student debt cancellation and free or debt-free college 17 SECTION 2: THE MECHANICS OF STUDENT DEBT CANCELLATION 18 The Mechanics of Student Debt Cancellation Carried Out by the Government 18 Current servicing of student loans from a balance sheet perspective 18 Possible methods of government-financed student debt cancellation 19 The government cancels the Department of Education’s loans all at once 20 The government cancels the Department of Education’s loans as borrowers’ payments come due 21 Government-led debt cancellation where the government assumes payments on student loans issued by 22 private investors Government-led debt cancellation where the government simultaneously purchases and then cancels loans owned 24 by private investors Government-led debt cancellation where the government purchases student loans issued by private investors and 25 cancels principal as payments come due Concluding remarks on government-led cancellation of privately owned student loans 26 Concluding remarks on government-led debt cancellation 26 The Mechanics of Student Debt Cancellation Carried Out by the Federal Reserve 27 The Federal Reserve purchases the Department of Education’s loans 27 Some fundamentals of the Federal Reserve’s remittances and their relevance to student loan cancellation 28 The Federal Reserve cancels the Department of Education’s loans all at once 28 The Federal Reserve cancels debt service payments for the Department of Education’s loans 29 The Federal Reserve assumes debt service payments for loans owned by private investors 31 The Federal Reserve purchases and cancels loans owned by private investors 32 The Federal Reserve purchases loans owned by private investors and cancels debt service payments 33 Potential options to avoid costs to the federal government of student loan cancellation carried out by the 34 Federal Reserve 4 Student Debt Cancellation Report 2018 SECTION 3: SIMULATING STUDENT DEBT CANCELLATION 36 Models and Assumptions Used for Simulating Student Debt Cancellation 36 Introduction to the Moody’s model 36 Introduction to the Fair model 37 Assumptions for the simulated student debt cancellation 37 Baseline values and macroeconometric simulation 38 Simulation Results 39 Conclusions from simulations 45 Omitted Benefits and Costs of Student Debt Cancellation 46 Small business formation 46 College degree attainment 47 Household formation 48 Credit scores 48 Household vulnerability in business cycle downturns 48 Moral hazard 49 CONCLUSION 50 APPENDIX A: SIMULATION DATA SERIES 52 APPENDIX B: DEPARTMENT OF EDUCATION LOANS AND THE BUDGET DEFICIT 55 APPENDIX C: DIGRESSION ON THE FED’S OPERATIONS 58 NOTES 61 REFERENCES 64 Levy Economics Institute of Bard College 5 Executive Summary1 • The policy of debt cancellation could boost real GDP by an average of $86 billion to $108 billion per year. Over the 10-year forecast, the policy generates between $861 billion and $1,083 billion in real GDP (2016 dollars). More than 44 million Americans are caught in a student debt • Eliminating student debt reduces the average unemploy- trap. Collectively, they owe nearly $1.4 trillion on outstanding ment rate by 0.22 to 0.36 percentage points over the 10-year student loan debt. Research shows that this level of debt hurts forecast. the US economy in a variety of ways, holding back everything • Peak job creation in the first few years following the elimina- from small business formation to new home buying, and even tion of student loan debt adds roughly 1.2 million to 1.5 mil- marriage and reproduction. It is a problem that policymakers lion new jobs per year. have attempted to mitigate with programs that offer refinanc- • The inflationary effects of cancelling the debt are macro- ing or partial debt cancellation. But what if something far more economically insignificant. In the Fair model simulations, ambitious were tried? What if the population were freed from additional inflation peaks at about 0.3 percentage points and making any future payments on the current stock of outstand- turns negative in later years. In the Moody’s model, the effect ing student loan debt? Could it be done, and if so, how? What is even smaller, with the pickup in inflation peaking at a triv- would it mean for the US economy? ial 0.09 percentage points. This report seeks to answer those very questions. The • Nominal interest rates rise modestly. In the early years, the analysis proceeds in three sections: the first explores the current Federal Reserve raises target rates 0.3 to 0.5 percentage points; US context of increasing college costs and reliance on debt to in later years, the increase falls to just 0.2 percentage points. finance higher education; the second section works through the The effect on nominal longer-term interest rates peaks at 0.25 balance sheet mechanics required to liberate Americans from to 0.5 percentage points and declines thereafter, settling at student loan debt; and the final section simulates the economic 0.21 to 0.35 percentage points. effects of this debt cancellation using two models, Ray Fair’s US • The net budgetary effect for the federal government is modest, Macroeconomic Model (“the Fair model”) and Moody’s US with a likely increase in the deficit-to-GDP ratio of 0.65 to 0.75 Macroeconomic Model. percentage points per year. Depending on the federal govern- Several important implications emerge from this analysis. ment’s budget position overall, the deficit ratio could rise more Student debt cancellation results in positive macroeconomic modestly, ranging between 0.59 and 0.61 percentage points. feedback effects as average households’ net worth and dispos- However, given that the costs of funding the Department of able income increase, driving new consumption and investment Education’s student loans have already been incurred (dis- spending. In short, we find that debt cancellation lifts GDP, cussed in detail in Section 2), the more relevant estimates decreases the average unemployment rate, and results in little for the impacts on the government’s budget position relative inflationary pressure (all over the 10-year horizon of our sim- to current levels are an annual increase in the deficit ratio of ulations), while interest rates increase only modestly. Though between 0.29 and 0.37 percentage points. (This is explained in the federal budget deficit does increase, state-level budget posi- further detail in Appendix B.) tions improve as a result of the stronger economy. The use of • State budget deficits as a percentage of GDP improve by about two models with contrasting long-run theoretical foundations 0.11 percentage points during the entire simulation period. offers a plausible range for each of these effects and demon- • Research suggests many other positive spillover effects that are strates the robustness of our results. not accounted for in these simulations, including increases in A one-time policy of student debt cancellation, in which small business formation, degree attainment, and household the federal government cancels the loans it holds directly and formation, as well as improved access to credit and reduced takes over the financing of privately owned loans on behalf of household vulnerability to business cycle downturns. Thus, borrowers, results in the following macroeconomic effects (all our results provide a conservative estimate of the macro dollar values are in real, inflation-adjusted terms, using 2016 as effects of student debt liberation. the base year):2 6 Student Debt Cancellation Report 2018 Introduction 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 stag- nant real incomes and higher average balances combine to There is mounting evidence that the escalation of student debt divert a larger portion of household resources toward debt ser- in the United States is an impediment to both household finan- vice and away from consumption and investment. cial stability and aggregate consumption and investment. The It is possible for the federal government to reduce or remove increasing demand for college credentials coupled with rising the burden of student loan debt as a means of direct support costs of attendance have led more students than ever before to to household spending. In this report, we examine the mecha- take on student loans, with higher average balances. This debt nisms that facilitate debt cancellation using T-accounts to map burden reduces household disposable income and consump- the transactions associated with the program. In a government- tion and investment opportunities, with spillover effects across financed cancellation program, the current loan portfolio of the the economy. At the same time, the social benefits of investment Department of Education is cancelled and the federal govern- in higher education—including human capital accumulation, ment either purchases and cancels or takes over the payments social mobility, and the greater tax revenues and social contri- for privately owned loans.
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