What have we learned recently about US student-debt policy?

Something unique about the past couple of years is that the vast majority of student-loan borrowers weren’t paying their loans. In March 2020, as part of the CARES Act, the main legislation that was passed to combat the COVID-19 pandemic, borrowers of all federally held student loans had the option to pause payments. This pause was initially supposed to last three months. It ended up lasting more than three years. 

With University of Chicago’s Michael Dinerstein and Booth PhD student Ching-Tse Chen, I studied what happened to borrowers given this option. All of us went in thinking that people would use the extra cash on hand to pay down other debt, but that’s not what they did. What we actually saw is that borrowers took on new debts: mortgage debt, auto debt, and credit-card debt. They used that additional cash on hand to increase consumption.

The optimistic take on this is that implementing a debt-payment pause is a cheap way to do stimulus. There is a cost to the government in terms of forgone interest, but it’s much cheaper than giving people cash. On the other hand, these households ended up with more debt, and that could depress consumption and household investment in the future.

How do the effects of pausing loans compare with the likely effects of canceling them?

It’s hard to predict these things, but given what we know, a debt moratorium would have a larger economic impact than loan forgiveness.

Keep in mind that a lot of people aren’t fully paying down their loans anyway because of programs such as Income-Driven Repayment. During the pause, there was an executive action promising significant student-loan forgiveness, of $10,000–$20,000 for most borrowers. But a single mom raising two children and earning $50,000 a year won’t benefit from $10,000 in forgiveness because she will likely have more than that forgiven through IDR. 

A lawyer with $200,000 in debt would benefit dollar for dollar from any forgiveness he or she qualified for, but there’s a lot of research demonstrating that higher-income individuals have lower marginal propensities to consume, meaning they spend less of any additional dollar they receive. If the government wants to support people who could most use an additional dollar, the best way is through IDR. 

But you also don’t want to be too generous with the terms of those plans, because schools are good at capturing government aid and loans. I have research with Sabrina Howell at New York University and Charlie Eaton at the University of California at Merced demonstrating that when private-equity funds acquired for-profit colleges, they hiked up tuition and captured more dollars in student aid. If we make things too generous, that generosity may ultimately end up being absorbed by schools and their PE backers instead of students.

Constantine Yannelis is associate professor of finance and FMC Faculty Scholar at Chicago Booth.

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