The Effects of the Resumed Federal Student Loan Payments on the US Economy

Introduction

A potential US default and the drama surrounding it quickly faded away after Congress approved a debt ceiling deal. However, there are still several provisions of the deal that have yet to be felt. One of the most notable effects is the resumption of federal student loan interest payments on September 1, 2023. This requirement, along with the other government policies, is expected to have a significant impact on the US economy starting in the third quarter of this year.

The Impact of Resumed Student Loan Payments

The Coronavirus Aid, Relief, and Economic Security Act, followed by subsequent executive orders, halted federal student loan payments as part of the policy response to the pandemic. This relief has been extended multiple times, allowing borrowers to avoid making monthly payments for more than three years. However, the resumption of payments for most of the $1.6 trillion in student debt implies a substantial headwind for the US economy.

The resumption of student loan payments is expected to have the following effects:

1. Financial Burden on Borrowers: The requirement to resume payments will place a significant financial burden on borrowers who have been accustomed to the temporary relief. This sudden increase in expenses may lead to reduced discretionary income and decreased consumption, impacting economic growth.
2. Macroeconomic Impact: The resumption of payments is likely to have a broader macroeconomic impact on the US economy. The widely cited estimate of $60 billion annualized may be surpassed when considering the full sample of loans under forbearance and the average federal loan interest rate of 6.36 percent. Estimations indicate payments in the range of $100 billion annually.
3. Increased Debt Levels: While borrowers benefited from the debt moratorium, many took advantage of the temporary increase in cash flow to accumulate more debt in the form of mortgages, car loans, and credit card loans. As payments resume, households must now pay off both their original debt load and the additional loans, potentially contributing to increased financial stress.
4. Volatility from Other Government Policies: In addition to the resumption of student loan payments, other government policies, such as tax filing deadline changes, may add to the volatility in the second half of 2023. The shift in the tax deadline for areas affected by natural disasters could impact US discretionary income by $30-$50 billion in the fourth quarter.

Unequal Distribution of Payments

The resumption of student loan payments will not affect all American households equally. Higher-income households, which account for a significant portion of the payments, also hold the majority of the excess savings accumulated during the pandemic. While they may still have some reserves to meet these payments, their overall excess savings may be depleted. Conversely, lower-income households without substantial excess savings may face even greater challenges.

Estimations suggest that annualized monthly payments could consume up to 5 percent of the remaining excess savings for the average person. However, when excluding the highest income quintile, the impact on excess current savings rises significantly to around 37 percent, highlighting the potential strain on these households.

Ramifications for the US Economy

The resumption of federal student loan payments, combined with other government policies, comes at a time when the US economy is already slowing. The accumulated excess savings have served as an important support for overall US growth, but higher debt service costs will reduce this support and further dampen economic growth.

A study by the Federal Reserve Board estimated that the resumption of student loan payments could have an annualized impact of $100 billion on the US economy. This significant reduction in discretionary income and potential decrease in consumption will pose challenges to economic recovery.

The Way Forward

Considering the impending challenges resulting from the resumption of student loan payments, policymakers and financial institutions need to be prepared to support borrowers and mitigate the negative impacts on the US economy. Some potential measures include:

• Implementing targeted relief programs for borrowers with financial hardships
• Offering loan repayment options based on income and ability to pay
• Strengthening financial literacy programs to educate borrowers on managing debt
• Supporting initiatives to increase access to higher education without burdening individuals with excessive student loan debt

Conclusion

The resumption of federal student loan payments after a long period of relief is expected to have a significant impact on the US economy. The financial burden on borrowers, the macroeconomic implications, and the unequal distribution of payments are factors that will shape the economic landscape. Understanding these effects and implementing appropriate measures will be crucial in navigating the challenges and ensuring sustainable economic growth.

Summary

Although Congress has approved a debt ceiling deal, the effects of some provisions are yet to be felt. The resumption of federal student loan interest payments will pose a significant headwind to the US economy. The financial burden on borrowers, the macroeconomic impact, and the unequal distribution of payments are factors to consider. It is estimated that annualized payments could surpass $100 billion, adding to the existing economic challenges. Policymakers and financial institutions should take steps to support borrowers and address these issues to ensure sustainable economic growth.

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The writer is an economist and managing director of Pimco.

Although the drama over a potential US default has faded quickly since Congress approved a debt ceiling deal last month, the effects of several provisions of the deal have yet to be felt.

Perhaps most notable is the requirement that all federal student loan interest payments begin accruing again on September 1, 2023, with payments due in October. The resumption of payments for most of the $1.6 trillion in student debt slope portends a significant headwind in the US economy beginning in the third quarter of this year.

The Coronavirus Aid, Relief, and Economic Security Act, signed into law in March 2020, followed by subsequent executive orders from the Trump and Biden administrations, halted federal student loan payments as part of the policy response to the pandemic. The pause, which has been extended eight times, has meant that for more than three years about 20 million people who borrowed to finance higher education costs have not had to make their estimated average payments of about $200-$400 a month, according to US Federal Reserve figures.

In addition, about 16 million student loan borrowers, who had already been approved for the Biden administration’s loan cancellation program, will also not get relief after the US Supreme Court ruled. recently ruled that the White House had no authority to cancel those loans.

The additional bill many American consumers are now facing comes as the economy is already slowing due to the lagged effects of tightening monetary policy and stress in the banking sector.

We believe that the macroeconomic impact of the resumption of payments will be significant for several reasons. First, the figure may be higher than the widely cited $60 billion annualized estimate. That was based on a study by the Federal Reserve Board of a subset of loans as of the first quarter of 2020. However, looking at the broader sample currently under forbearance, and the recent average federal loan interest rate of 6.36 percent, we estimate that the payments are likely to be in the area of ​​$100 billion annualized.

Second, despite excess savings, debt evidence collected by credit rating agencies suggests that American consumers used the temporary increase in cash flow from bankruptcy to borrow more. A recent University of Chicago paper It highlights that borrowers who benefited from the debt moratorium significantly increased their mortgage, car and credit card loans on average. As payments resume, these households must now pay off their original debt load, as well as the additional loan.

Third, the resumption of student loan payments is not the only government policy likely to cause volatility in the second half of 2023. The tax filing deadline for areas affected by natural disasters, including California, has been pushed back from April to October. While this temporarily boosted consumption in April, we expect a recovery in October. We estimate that the tax date change could have a $30-$50 billion impact on US discretionary income in the fourth quarter.

To be sure, the effect of discretionary income payments will not be felt equally by all American households. Student loan debt payments are skewed toward higher-income households, with 28.1 percent of payments coming from the top 20 percent of the income distribution, according to data from the Fed and Brookings Distributional Financial Accounts . These same higher-income households account for 80 to 90 percent of the excess savings accumulated since the start of the pandemic, suggesting they still have some reserve to help meet these payments.

However, higher interest payments are likely to eat into the overall excess savings that many households accumulated during the pandemic and will weigh on savings and consumption decisions for years to come. Annualized monthly payments are estimated at 5 percent of excess savings remaining for the average person, while excluding the highest income quintile, the estimated impact rises to around 37 percent of excess current savings, a ratio significant.

The bottom line is that changes in government policy add to macroeconomic volatility at a time when the US economy is already slowing. While we continue to believe that healthy household balance sheets can help cushion the broader economy, the impact of higher debt service costs will reduce what has been an important support for overall US growth.

Pimco’s Libby Cantrill contributed to this column