Student Loan Forgiveness Plan and Inflation Reduction Act: Are These New Policies Inflationary or Deflationary?

Inflation is top of mind for consumers and market participants. In the United States, many are questioning whether student loan forgiveness will make inflation worse, and if the recently passed “Inflation Reduction Act” will offer relief. Franklin Templeton Investment Solutions’ Gene Podkaminer and Spencer Walling weigh in on whether these new policies will worsen the current inflationary environment, or prove to provide a deflationary impulse for the economy.

Student loan forgiveness

US President Joe Biden’s student loan forgiveness plan will forgive up to $10,000 per borrower, and for Pell Grant recipients, up to $20,000. The plan is eligible for individual borrowers with income up to $125,000 or households with income up to $250,000. Overall, the debt forgiveness plan would reduce student loan balances by around $400 billion (1.6% of gross domestic product) if all borrowers eligible for the program enroll.1 On the surface, this plan appears inflationary since it lowers the debt levels of US consumers, which has prompted many to think of this as Biden’s new version of fiscal stimulus.

However, we believe this is far from reality. The Congressional Budget Office estimates that $10,000 student debt cancelation would hold a 0.13x fiscal multiplier,2 compared to COVID-19 relief measures, which held a 0.4x-0.9x multiplier. Given that the student loan forgiveness has a much lower fiscal multiplier, we expect the impact on consumer spending will not be nearly as powerful as the fiscal stimulus payments that were issued during the COVID-19 pandemic. Moreover, the benefits from the loan forgiveness will be extended out over time as consumers will pay their reduced monthly repayments going forward. Those who have had their monthly payments eliminated entirely from the loan forgiveness will not see a significant effect on spending, given almost all of the student loan borrowers have not been making monthly payments since the enactment of loan forbearance during the COVID-19 pandemic.