Student Loan Forgiveness vs. Inflation
There has been a lot of news coverage of the Supreme Court’s decision to strike down the Biden Administration’s plan to forgive student loan debt. However, there hasn’t been much coverage on how that will impact inflation. Inflation occurs when demand is up, and the amount of supply is down. That mismatch of demand being higher than supply pushes prices higher. The secondary cause of inflation is the creation of more dollars through debt financing or pulling forward demand from the future by borrowing and spending today. The rejection of the student loan forgiveness plan hits inflation in both spots. Since 2020, the average student loan borrower hasn’t had to pay a dollar back in student loans. These payments will start in October, making student loan borrowers owe $383 monthly. That will reduce demand by $383 a month. Secondarily, writing off this policy immediately eliminates a projected $400 billion additional debt. Bringing demand down and reducing debt should hit inflation in the short term, starting in October. The positive impact could be deflationary pressure, bringing prices down as spending is diverted from goods and services into these loan repayments. It will be stressful for the borrower but should also put pressure on prices, which should be a net benefit economy-wide. This is something we will continue to watch closely.
We received good headline numbers last week as Consumer Sentiment and Consumer Confidence were at their highest since early 2022. Consumers are starting to get more confident even with student loan repayments coming. The Fed announced last week that all 23 banks they tested this year passed their stress test. The stress test included a 10% unemployment rate, a 38% decline in home prices, and a 40% drop in the value of commercial real estate. Even though all those banks passed the stress test, it’s important to point out that before the Silicon Valley Bank collapsed, it also passed a stress test. One thing that’s missing in the stress test is the liquidity crunch. That is what happened to the Silicon Valley Bank, which we see possibly becoming an issue with other banks. This test was only run on 23 banks, so that’s not the entire United States worth of banks. There are a lot of regional banks that were left out of this test. With the Fed still having quantitative tightening and half of the Treasury’s new debt issuance being funded by bank reserves. We’re seeing this liquidity crunch on the weekly change of bank reserves. They have fallen $130 billion in two weeks, and we expect a larger drain this week with the Fed balance sheet runoff continuing. We need to keep an eye on that in this liquidity crunch. While it’s great that they passed the stress under these specific scenarios, we want to see how they do with liquidity. Bank reserves and liquidity correlate strongly and are something we will keep an eye on going forward.
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