Student Loans, Wages, and Inflation

As the college school year comes to an end many people will be graduating and looking for a job. These new graduates will be faced with a difficult job market where they encounter the distinct possibility of being underemployed. Of these graduates about 71% will have student loan debt averaging $29,400, which has increased 6% per year since the beginning of the Great Recession. The debt burden for college graduates has been increasing, eclipsing $1 trillion in 2013 with around 40 million people having student loan debt. In recent years, student loan debt has surged past credit card debt and auto loans to come second only to housing debt in size. As the cost of college education continues to increase and outpace inflation the student loan debt crisis will continue to grow.

Student loan debt has grown significantly as a problem in the past decade due to increased tuition but also because of wage stagnation. The real median earnings (in constant 2011 dollars) of young college graduates with a bachelor’s degree has dropped from $52,130 in 2000 to $44,970 in 2011. The situation has put a drag on the economy, helping prevent a strong recovery because young adults forgo starting a family, buying a house, buying a car, and other large purchases because they have to devote a larger portion of their earning to paying off their student loan debt. As John T. Harvey, an economist from Texas Christian University, states:

“we are spawning a generation whose debt loads are already so high that they will be forced to forego the consumption necessary to create demand and employment for the rest of us–and consumers are the true job creators. We need them to spend the money that makes entrepreneurial activity profitable, but what sort of expenditures can we expect from a recent graduate who already faces the equivalent of a house payment?!”

To alleviate this growing burden we need to return to full employment as fast as possible and inflation needs to hit or exceed the target 2% in the coming years.

Returning to full employment will help everybody including young college graduates. Reaching full employment means that the slack in the employment market disappears as the workforce is fully utilized, and therefore employees have the bargaining power to demand higher wages. A rise in wages will allow people to repay their student debt with a smaller percentage of their income. This will allow people to use their additional spending power to create demand in goods and services  which will spur more economic expansion and more demand for labor. It is in the interest of everyone that full employment is reached as soon as possible.

To reach full employment the Federal Reserve could do more to spur growth. The two mandates of the Federal Reserve is maximum employment and stable prices. The Fed has failed on both mandates since the Great Recession. Unemployment and inflation are countervailing, which means that generally if inflation increases unemployment decrease and vice versa.  This country has experienced high unemployment and low inflation since the onset of the recession. Starting in 2012 the Federal Reserve has targeted inflation at 2%. Since the adoption of the target, the interest rate was at or above 2% for only 3 months. Those three months being the first three months of targeting. To maintain their credibility and truly target 2% inflation the Fed needs to support sufficient demand for inflation to reach and exceed the 2% target. Because federally-backed student loans often have fixed interest rates, higher inflation lowers the real burden of paying off student loans as inflation reduces the burden of the debt. Kenneth Rogoff, an economist from Harvard University and one of the most influential economists in shaping policy in response to the crisis, has stated that “Weighed against the political, social, and economic risks of continued slow growth after a once-in-a-century financial crisis, a sustained burst of moderate inflation (4-6%) is not something to worry about.” If 4-6% inflation were to occur then more improvements in debt balances would occur. The reason for this is that with a higher inflation rate unemployment would drop tightening the slack in the labor market and it leads to higher wages. Though the cost of goods also goes up, your student loan cost stays the same, which means that the overall real cost of student loans decrease.

For our economy to recover we need an aggressive economic policy that works to create good jobs and lower the debt burden of people that are working to improve themselves and and their economic position. Student loan debt is a big hindrance to a more productive and stable economy.

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