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The writer is an economist and a managing director at Pimco
The recent resolution of the potential US default has calmed the drama, but the consequences of certain provisions in the agreement are yet to be felt.
One notable provision is the reinstatement of interest payments on federal student loans starting from September 1, 2023, with payments due in October. With over $1.6 trillion in outstanding student debt, this will pose a significant economic challenge for the US in the third quarter.
The relief from student loan payments, which began with the Coronavirus Aid, Relief, and Economic Security Act in March 2020, followed by subsequent executive orders, has provided temporary respite to millions of borrowers. However, the resumption of payments will affect approximately 20 million individuals who have been spared from monthly payments averaging $200-$400, according to the US Federal Reserve.
In addition, around 16 million borrowers who were expecting loan cancellations under the Biden administration were disappointed by a recent US Supreme Court ruling that deemed the cancellation authority unconstitutional.
This renewed financial burden on consumers comes at a time when the economy is already slowing due to monetary policy restrictions and banking sector stress.
Our analysis suggests that the economic impact of loan payment resumption will be significant for several reasons. First, the total amount may exceed the estimated $60 billion annualized figure. Taking into account the wider sample of loans and the recent average interest rate of 6.36%, we estimate payments could reach around $100 billion annually.
Second, despite the existence of excess savings, evidence shows that consumers used the payment holiday to accumulate more debt. As payments resume, households will have to service their original debts as well as the additional borrowing.
Third, the resumption of student loan payments is not the only government policy change that will introduce volatility in the second half of 2023. The shift of the tax-filing deadline for disaster-affected areas to October will have a negative impact on discretionary income, estimated to be between $30 billion and $50 billion in the fourth quarter.
It is important to note that the impact on discretionary incomes will not be evenly distributed. Higher-income households account for a significant portion of student loan payments and also hold the majority of excess savings. However, these higher interest payments will erode the overall savings and consumption decisions of households in the coming years.
In conclusion, government policy changes are contributing to macroeconomic volatility at a time when the US economy is already slowing down. While households with healthy balance sheets can provide some cushion, the higher debt service costs will diminish the support they have been providing to overall US growth.
Contribution by Libby Cantrill of Pimco
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