Compounding Benefits of Loan Cancellation

By Jonathan Glater | June 17, 2020

In the debate over the relative costs and benefits of student debt cancellation, there should be more serious consideration by policymakers of the compounding benefits. That is, while wiping out any borrower’s debt is a benefit to that borrower, all borrowers will not react in the same way to the same amount of cancellation. Some borrowers are more likely to spend the money made available by debt cancellation—and to spend larger amounts—than others. And because cancellation in this time of pandemic-driven financial hardship aims both to help individual borrowers and to encourage economic recovery, these differences matter.

Economists capture these differences in the marginal propensity to consume, which is the fraction of new income that someone will turn around and spend. For example, if a consumer is given an additional $1,000, saves $600, and spends $400, then that consumer’s marginal propensity to consume is 0.4, for $400 out of $1,000.

Thus, if a policymaker wants to eliminate debts to benefit individual borrowers and at the same time to drive economic growth, it makes sense to target cancellation at borrowers who have a higher marginal propensity to consume.

This is not terribly controversial stuff. Alan Kreuger, former chairman of the Council of Economic Advisers in the Obama Administration, noted nearly a decade ago that people who have lower incomes have a higher propensity to consume—which is not surprising because people with lower incomes need to spend more of their income to meet their minimum basic needs. If debt cancellation is directed toward people who earn less, they will then spend that money after receiving relief, thereby supporting other businesses and the larger economy.

Of course, this is more complicated and many factors affect individual spending decisions—but you get the idea.

This argument is the complement to one made by the Student Borrower Protection Center a couple of weeks ago, in a report prepared in collaboration with Credit Builders Alliance: just as alleviating student debt obligations helps borrowers and has compound benefits, the ongoing burden of the same indebtedness increases the cost of credit for borrowers and so reduces their spending ability. This is in addition to some evidence that reducing or eliminating student borrowers’ repayment obligations leads them to reduce other forms of debt, improving their financial health.

In the dire economy the nation now faces, forgiving anyone’s debt should help to counter economic contraction. And some more recent research suggests that differences in the marginal propensity to consume across different groups may be smaller than previously thought. But the aggregate benefit of stepped-up spending by student borrowers relieved of payment obligations should be considered alongside the potential cost of any cancellation.

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Professor Jonathan Glater serves on the faculty of University of California, Irvine School of Law, where he leads the Student Loan Law Initiative.