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Would Forgiving Student Loans Stimulate the Economy?

Mark Kantrowitz

August 09, 2009

Would Forgiving Student Loans Stimulate the Economy?

Several grass-roots groups were established on Facebook in early 2009 calling for the cancellation of all student loan debt under the theory that this will stimulate the economy.

Most noteworthy is the group Cancel Student Loan Debt to Stimulate the Economy

(see also founded by Robert Applebaum, a New York attorney. This group has grown to have more than 220,000 members in just seven months. Another group, Stimulate the Economy -- Forgive Student Loans

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is running a petition drive and has collected more than 40,000 signatures.

These groups have attracted attention from news media in part because of their rapid growth. Recent coverage includes

The Huffington Post (February 5, 2009), US News & World Report (March 8, 2009), BusinessWeek (March 24, 2009), Washington Times (March 30, 2009), University Business (March 2009) and USA Today (May 12, 2009).

Would Loan Forgiveness Stimulate the Economy?

Both Mr. Applebaum and Mr. Bartoy argue that canceling all outstanding student loan debt would stimulate the economy and be more effective than the American Recovery and Reinvestment Act of 2009. For example, Mr. Applebaum writes "Forgiving student loan debt would have an IMMEDIATE stimulating effect on the economy." He argues that this would have a multiplying effect, that "tax revenues would go up, the credit markets will unfreeze and jobs will be created" and that "the fastest way to revive our ailing economy is to do something drastic to get consumers to spend".

The Honorable Jim Sano, Chair of the Finance Committee for the Albany Common Council, has echoed these ideas in a proposed resolution calling on Congress to "offer programs to reduce student loan debt as an economic stimulus tool". The Albany Common Council passed the loan forgiveness resolution on Monday, August 17, 2009 by a vote of 12 to 0.

It is an interesting idea, but would forgiving all student loan debt actually stimulate the economy?

Unfortunately, the stimulative effect of this proposal would be minimal because the annual payments on the debt amount to less than 4% of the debt. Let's review the math:

  • There's about $598 billion of federal education loans outstanding and about $132 billion of private student loans outstanding, a total of about $730 billion.

  • Only borrowers in active repayment and who are current on their loans would derive a cash flow benefit from loan forgiveness. While borrowers who are in a deferment or forbearance, delinquent or in default might derive a financial benefit from having their debt canceled, such forgiveness would not translate into increased consumer spending.

    • About half of all private student loans are in repayment, and of those, about one-fifth are either delinquent or in a forbearance. So only about 40% of outstanding private student loans are in active repayment and current.
    • Nearly 60% of federal education loans are in repayment, and of those, about a third are either delinquent or in a deferment or forbearance. So only about 40% of outstanding federal education loans are in active repayment and current.
    • 40% of $730 billion is $292 billion.

  • Most borrowers of federal education loans consolidate their loans to obtain an extended repayment, typically with a term of 20 years. Most private student loans also have a repayment term of 20 years. Assume an average interest rate of 7.0% on federal education loans and 11% on private student loans. Then the current annual payments on the education debt that is in active repayment total about $28.8 billion, 9.9% of the debt in active repayment and 3.9% of the $730 billion in outstanding debt.

So assuming that the borrowers would spend this windfall instead of saving it or using it to pay down other debt, this proposal would involve the government spending $730 billion now in order to increase consumer spending by $28 billion. Since less than 4% of the cost of this proposal would be spent by consumers in the first year, it will clearly not have the "immediate stimulating effect" claimed by the proposal's proponents.

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