Key takeaways

  1. The restart of student loan payments is likely to be the most impactful part of the debt ceiling agreement in the near term
  2. Debt ceiling deal will have limited impact on investments
  3. A minor provision in the restart of student loan payments could significantly impact consumer spending and inflation
  4. Federal student loans are set to restart on September 1 per the agreement
  5. 44 million Americans with federal student loans totaling $1.6 trillion will be impacted

It is somewhat ironic that despite all of the angst over the debt ceiling these last few months, the ultimate deal turned out to be a pretty straightforward budget agreement. 

In terms of investment impact, the budget cuts envisioned by this deal will probably have a limited impact. In fact, we think one of the most important impacts of this agreement could be one of its more minor provisions. 

Specifically, as part of the negotiations, the White House and Republicans agreed to a firm date for when student loan payments will restart. 

We think this could have a material impact on consumer spending, and therefore inflation, in the later part of this year. 

Here’s why.

Student loan payments have been on “pause” for three years

During the onset of COVID, a series of measures were taken to support the economy. As part of one of these bills, payments on student loans were put on pause starting in March 2020. Initially, that was supposed to only last three months, but the restart date was extended several times, twice by President Donald Trump and four times by President Joe Biden.

Payments were already scheduled to restart on September 1. The debt ceiling deal merely cemented that date by both sides agreeing not to extend the payment moratorium further. 

The payment freeze was probably a major stimulus for consumer spending

There are 44 million Americans with federal student loans totaling $1.6 trillion. 

Estimates for how much borrowers will be paying once the forbearance ends range. The last time the Federal Reserve asked this question in their annual consumer borrowing survey, the average was $393 per month

A more recent report from the New York Fed estimated that 37 million consumers saved $98 billion per year over the program’s first two years. This would imply average payments of $220 per month per borrower.

How big of an impact will this have on total consumer spending? In April 2023, total consumer spending was at an $18 trillion annual pace. 

Therefore, the $98 billion boost to consumers via student loan deferrals represents 0.5% of total spending. 

Restarting loan payments will function like a tax hike or gas price increase

From an economic perspective, the end of student loan deferral will function a lot like a tax hike for the impacted households. 

A certain amount of money put into the economy will now go to the government. Note that the largest recent increase in personal tax rates, which took effect in 2013, only raised $60 billion per year in new tax dollars. Adjusting for inflation since 2013, that would be $78.6 billion in today’s dollars.

Another good comparison is the increase in gas prices. Normally, rising gas prices cause consumers to spend less on other items to compensate. 

In 2022, Americans consumed 134.55 billion gallons of gas. At today’s average price per gallon, that would imply spending of about $480 billion per year on gas. 

To get the same $98 billion per year impact as the student loan restart, gas prices would have to rise 20% or about $0.75 per gallon.

Concentrated impact could make the economic effect larger

The effects of restarting student loan payments will concentrate on a certain demographic - specifically, people under 40. According to the New York Fed, 55% of student loan balances are held by this group.

Source: Federal Reserve Bank of New York

According to the Department of Education, the average college grad between the ages of 25 and 34 working full-time earns $65,000 per year. 

Assuming a single person with no dependents, such a person would pay approximately $7,000 per year in taxes

According to Moody’s, the average renter spends 30% of their income on rent, which implies another $17,000 per year in housing costs. This leaves $41,000 per year, or $3,400 per month, in available income for all other purposes.

The range of estimates for the typical student loan payment mentioned above was between $200 and $400 per month. That amounts to between 6% and 12% of available income for someone in the situation described above.

Note that we aren’t trying to make a point about what is fair or not. Rather, we are pointing out that the payment restart for those with student loans will represent a meaningful percentage of their disposable income. 

Given that fact, it is likely to have a substantial effect on their spending habits, which in turn will matter for economic growth.

This could have a material impact on inflation

We have been saying for a while now that inflation is primarily driven by excess consumer demand—and to get inflation back under control—spending will have to slow

Total consumer spending is running about $1.5 trillion above its pre-COVID trend, so $98 billion less spending from student loan holders will only put a minor dent in that excess.

Source: Bureau of Economic Analysis

However, we don’t really know how much of a decline in spending will get inflation back to normal. All we know is that spending is outpacing the economy’s ability to produce. It may require a relatively small change in spending for inflation to subside.

In addition, this student loan restart isn’t the only thing currently influencing inflation. The Fed’s rapid rate hikes over the past two years are definitely impacting the economy. 

Housing market activity has plunged, job growth has slowed, and banks are becoming more cautious about lending. Even inflation, which is still way too high for the Fed’s liking, has slowed a good bit from its 2022 highs.

So while we don’t expect student loan payments to be the primary reason why the economy slows, or inflation subsides in the coming months, it is yet another factor weighing on the economy. 

At least in the near term, we think it will be the most impactful part of the debt ceiling agreement.