Background
It's no secret that inflation is here. For how long, we're not sure, but it's felt everywhere you spend money. From expensive eggs at the grocery store, to heightened prices at the gas pump, the average consumer is feeling inflation eat away at their wallet.
Inflation is typically measured against the CPI, or the Consumer Price Index. The index is a collection of goods and products that the U.S. government compares prices against year over year. Though the CPI has its fair criticisms, it's still a decent metric to confirm the state of inflation. As a lagging indicator, the index trails monthly behind the economy. Markets were relieved to see that in late 2022, inflation was coming down.
However, it's not as promising as it appears. And, unfortunately for student loan borrowers, inflation is here to stay. Peaking near 9%, as according to the CPI last year, inflation blew past the Federal Reserve's target of 2%. This means that every year, the Federal Reserve targets 2% expansion of the monetary supply; effectively debasing the dollar's value at a 2% rate each year to provide liquidity in the economy. Even if the Federal Reserve manages to wrangle inflation back down to a 2% year over year figure, it won't be the 2% inflation of old. Rather, with the government's lax fiscal policy, stimulus checks, ironically-named inflation relief packages, and activity of the money printer, somewhere between 32% and 40% of all circulating U.S. dollars were printed within the last few years. Because of this, a new monetary paradigm was ushered in: one where the supply was greatly increased in a short amount of time. Because of this, the 2% inflation target the Federal Reserve typically targets is now 2% of the additional 32% to 40% expansion in the monetary supply.
As an example, imagine the entire monetary supply of U.S. dollars was $100. The Federal Reserve wants that amount to expand 2% year over year. 2% of 100 is two. In year one, the amount of circulating dollars would be $100. Year two: $102. Year three: $102.40, and so on. Now imagine that in year one the monetary supply was increased by 40%. In year two, the circulating dollars would amount to $140. Let's say inflation remained at 2%. In year three, the circulating dollars would amount to $142.80. Though this may not seem like a huge increase, in example one the circulating supply only jumped $00.40 whereas in example two, the figure jumped $2.80. That's roughly a 14% increase. And due to the power of compounding interest, this number accelerates higher and faster than a world that never printed 40% of circulating dollars. It should be no surprise that this drastic increase makes affording to live even more difficult for strained borrowers.
How borrowers are impacted
Because inflation is rampant at the moment, the ability to afford normal goods has become more difficult. Because of this, borrowers have less money to put towards their loans should they need to allocate funds to more immediate needs like food or shelter. Borrowers should be relieved they have fixed interest rates that do not fluctuate over time, but can still feel the tightness when it comes to spending. Because of inflating prices, borrowers are having to undertake austerity measures to ensure they can meet their financial obligation to the government or their private student loan provider. These measures entail putting less money towards investing, less saving, taking less vacations, opting for lower price and/or quality of food, and so on. This is the pernicious nature of inflation: it deters individuals from investing in their future as they may have to scramble to afford the present.
An alarming statistic that's effecting the U.S. economy is the drastic increase in revolving credit usage. Simply put, Americans are relying more on their credit cards to afford the goods and services they were used to before increased inflation took hold. Credit cards notoriously have high interest rates, and Americans running up their balance are increasing their risk of default as annual percentage rates take effect. Student loan borrowers relying on their credit cards to get through an inflationary environment may be relieved in the short term, but put themselves at further risk in the future. Credit card balances can be expunged in bankruptcy. Student loans, of course, can not.
What can borrowers do?
If you're a student loan borrower worried about affording your loans and living, here are some things you can consider:
- Buy the less expensive alternative food item at the grocery store.
- Stay in more, go out less. It's no secret that going out for dinner, doing to the bar, or even getting coffee can run up quite a bill. Opt for nights in and self-prepared meals.
- Rethink big vacations. Instead of going to a beach resort, consider going camping or another less expensive outing.
- Maintain a budget to maintain visibility into spend.
- Seek additional employment. Consider freelancing, picking up some hours doing ride sharing, or pet or house sitting.
Good news
Borrowers should be relieved that inflation is heading in the right direction: downward. The tightness felt right now won't last forever. The economy experiences periods of growth and contraction due to the credit/debt cycle. Historically, every economic downturn has been followed with growth. The austerity measures borrowers are taking now will be worth it long-term.
Many economic pundits are calling for a recovery later this year, and at latest some time in 2024. As the Federal Reserve begins to taper its rate hikes, and confidence returns to the markets, the economy will improve and we can all let out a deep breath.
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