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.
Furthermore, student loan forgiveness influences savings and longer-term financial planning rather than near-term consumption habits. For example, surveys were conducted by the Brookings Institution and Social Policy Institute to assess how certain levels of student debt forgiveness would alter household behaviors.3 Their findings suggest that most student debt holders will use forgiveness to increase savings, rather than increase spending, which lowers the effect on inflation. Consumers will enjoy greater freedom to reduce other debt, given that outstanding student loans currently account for only 10% of total household debt.4
One could argue there is a deflationary impact from Biden’s plan, as it ends the student loan repayment moratorium. Since the beginning of the COVID-19 pandemic, there has been a freeze on repaying these loans, but that will end in January 2023. As the chart below shows, roughly 1.2% of all student debt borrowers have been repaying their loans. This will dramatically increase when the moratorium ends and force cash outflows upon consumers in the midst of persistently high inflation (leaving less money to spend on goods and services). The deflationary impulse from this resumption of payments will likely more than offset any potential inflationary aspects to loan forgiveness.
Overall, the inflationary effect of the student loan forgiveness plan is likely to be subdued.
Inflation Reduction Act (IRA)
In addition to the student loan forgiveness, Biden has signed into law the Inflation Reduction Act (IRA). The IRA includes some large provisions aimed at establishing a minimum corporate tax rate, prescription drug price reform, IRS tax enforcement, Affordable Care Act subsidy extensions, and energy security and climate change investments. The effects on consumer spending, however, are modest at best.
The IRA will take many years to ultimately come to fruition and start to impact the US economy. Regarding inflation, the impacts in the near-term will be minimal.
Reducing Medicare costs will be beneficial for consumers, but unlikely to provide a significant inflationary or deflationary impact given that prescription drugs account for approximately 1% of spending in the US Consumer Price Index (CPI).5 Biden’s tax credits for US consumers who purchase electric vehicles (EVs) will take significant time to gain momentum; most of the electric vehicles sold in the United States are not yet eligible for the tax credit due to production requirements for certain vehicle materials to be built in the United States. There are income caps as well for these EV tax credits; they will be available only to individuals making less than $150,000, and joint households with income of less than $300,000.
Finally, the IRA increases the total federal tax credit from 26% to 30% off solar energy investments; this increased credit is extended through 2032 before being reduced and later phased out into 2035. While this could potentially save consumers money through tax savings and lower energy expenses from using more solar over electricity, US solar-panel systems generally cost between $10,000 to over $25,000 after the pre-IRA 26% federal tax incentive.6Although the IRA tax incentives have risen to 30%, renewable energy up-front prices are still quite large, and consumers may have a tough time affording these costs in the current economic environment.
Our team will continue to monitor the long-term impacts resulting from the IRA but believe in the near-term any inflationary impacts from the bill will be minor. In the longer-term, the ensuing decline of switching costs for households to use renewable energy should entice more consumer demand. However, we believe this will be a longer and more gradual process that will take place more heavily toward the end of the IRA’s time horizon of 10 years.
Outlook
Overall, both the student loan forgiveness plan and IRA are unlikely to have significant effects on inflation. Student loan forgiveness will benefit consumers as time passes and monthly payments are reduced, but now payments will have to be paid back starting January 2023. This will happen as roughly 45% of borrowers will have their debts fully canceled, according to Biden,7 still leaving a plethora of borrowers on the hook for repayments starting again after the end of this year. The IRA inflationary initiatives will take years to come to surface, face difficulty achieving, and impact CPI items that are not of significant weight. We still foresee inflation remaining elevated into 2023, as the consumer faces a challenging environment of negative real wage growth combined with an aggressive Federal Reserve.
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1. Source: J. Briggs, A. Phillips. Goldman Sachs Economic Research. US Daily: Student Debt Relief: The Headlines Are Bigger Than The Macroeconomic Impact, August 25, 2022.
2. The fiscal multiplier measures the impact that an increase in fiscal spending will have on a nation’s economic output (GDP). The fiscal multiplier takes into account the marginal propensity to consume, which measures the increase in consumer spending (rather than saving) resulting from increases in the income of an individual, household, or society.
3. Source: S. Roll, J. Jabbari, M. Grinstein-Weiss. Brookings Institution. Student debt forgiveness would impact nearly every aspect of people’s lives. May, 2021.
4. Source: Federal Reserve Bank of New York. Center for Microeconomic Data. Household Debt and Credit Report. Q2 2022.
5. US Consumer Price Index (All Items). Source: U.S. Bureau of Labor Statistics. Offices of Prices & Living Conditions. December 2021.
6. Range based on purchase price of 6 kilowatt and 10 kilowatt systems. Purchase price varies by location, kilowatt capacity, product type, and other factors. Source: J. Marsh. How much do solar panels cost in 2022? EnergySage, April 2022.
7. Source: President Biden. Press announcement of student debt loan forgiveness. August 24, 2022.
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