Debt – Guide to Liberty

Student Loans: Solutions vs. Delusions

by Guide To Liberty
April 17, 2016April 17, 2016

The total amount of federal student loans has been growing quickly. The following diagram from the Federal Reserve shows the growth of student loans since 2006.

The total amount at the time of writing is over 1.3 trillion dollars, and the federal student loan portfolio is 1.221 trillion dollars according to the latest data from the department of education. This huge increase in spending on student loans indicates both an increase in the number of people seeking a college education and a rise in the cost of college education.

The problem of student loans is one of the hot topics this election cycle with both presidential candidates on the left proposing some variations of free college to solve the problem. Many young students with large student loan balances surely cheer that, who doesn’t like free stuff? Free college may make some voters happy and may even win someone the elections but it won’t solve the fundamental problem with higher education.

Let’s start with asking why do people get a college education? Sound economic thinking says that they do that to raise their human capital and raise their productivity and income. College then is an investment that has expected return in the form of future earnings. People who don’t have the financial resources to make needed investments get loans to finance their projects. The interest rate on a loan is determined by the lender based on the borrowers’ ability to pay which depends on the risk of the project. So if two students with similar academic abilities applied for loans one for an engineering degree and the other for an animal studies degree the first will definitely get lower interest rate on his loan because an engineer has a higher earning potential than a person with an animal studies degree. The effect of interest rates will be to steer students towards more productive majors and only students who really are interested in low productivity majors will take the high-interest loans to get into these majors. The other effect of the interest rate is that they force borrowers to take the smallest loans that can meet their goals so each student will have a strong incentive to select the cheapest college program that gives him the education he needs. This will pressure the universities to be more efficient and offer better education packages to attract students with different budgets.

Government Spending vs. Revenue

by Guide To Liberty
April 10, 2016April 12, 2016

The classical view in democratic countries is that the government taxes the citizens to finance its spending. The Congress on the federal level and the legislature on the state level debate a yearly budget to spend the tax receipts on the different priorities. The government may raise the tax rates if it needs to spend more money that it bring in tax revenue. The reality of democratic politics is far from that classical view. Raising taxes and cutting government spending are both politically unpopular options, so governments use deficit spending.
To finance the deficit the government issues bonds and sell them to creditors. These bonds have different maturity dates, interest rates, and sale prices depending on the creditworthiness of the government, and they add a new item to the government’s budget which is the debt service for paying the interest rate on outstanding bonds and paying the face value of matured bonds. Because of the same political factors that prevent raising taxes and cutting government spending the government ends up having a deficit every year and these deficits accumulate and increase the government debt.
A common way to express the debt is as a percentage of the Gross Domestic Product (GDP), this gives an indication of the size of the debt in comparison to the economy. The debt to GDP ratio might hide the debt increase if the GDP grew at a higher rate than debt for few years, so it is important to look at the absolute value of debt as well. The following chart shows the growth of the federal debt as percent of the GDP: