Boom or Bust? What student loans are doing to college tuition

How do we know college tuition is rising?

The CPI (Consumer Price Index) is a way to measure historical prices of a product.

The CPI for all items, food and beverage, and housing as increased by 25% since 1978. Medical care has increased by over 600% while college tuition and fees has increase by almost 1300% within the same timeframe. This is an obvious example of the rising cost of college tuition.

So what is causing the rise of tuition?

Student Loans

A quick history on Federal Student Loans

In 1992, George H.W. Bush signed a reauthorization of the Higher Education Act of 1965 which established the Direct Loan Program. The program was intended to replace federally-backed private loans in order to lower costs, minimize confusion, ultimately make it easier to take out student loans.
Martin Olav Sabo (D-MN) introduced the Omnibus Budget Reconciliation Act of 1993 which set a phase-in of the direct loan program. The act was signed by Bill Clinton in 1993. The program was anticipated by congress to replace federally-backed student loans by 1998. In addition to the program phase-in, an interest rate change was scheduled for 1998.
However, by 1998, the Direct Loan Program didn't play as big of a role as congress had intended. As a result, lenders in the bank-based program – whom Congress assumed in 1993 wouldn’t be playing the major role in 1998 – expressed concerns that the interest rate change would increase their costs and reduce returns to such an extent that they would no longer be willing to make federally-backed student loans. Because of this, congress postponed the rate change until 2003.
In 2002, congress established a fixed 6.8% to take effect in 2006 instead of the scheduled 2003 rate change. However, by the time the law was established, the Federal reserve reduced the treasury rate from 6.1% down to 1% in response to a slight recession. This drastically reduced the cost of variable interest rate loans and consequently made the loans a really attractive option from 2002-2005.

So what do cheap loans have to do with rising college tuition?

The large increase of student loans drastically increases the cost of tuition because of the Laws of Supply and Demand.

The law of demand says that, if all other factors remain constant, the lower the price of a good, the more quantity of that good is demanded.
The law of supply states that, if all other factors remain constant, the higher the price of a good, the more of that good will be supplied.

When supply and demand remain equal, it is said that the economy is at equilibrium. However, shifts and movements in either or both of the supply curve and demand curve will cause the economy to go into disequilibrium.

One factor that causes a shift in the demand curve is the disposable income of the consumer. If the consumer sees an increase in disposable income, the demand curve will see a rightward shift causing an excess demand disequilibrium as seen above. This causes a rise in the price of the product.

The large amount of student loans is seen as an increase of disposable income for the student. This means that there will be a higher demand for a college education and, consequently, higher tuition costs to compensate for the increased demand. The higher costs require more loans to be taken out. What results is a never ending spiral of inflation.

And now puggo is sad because he's $30k in debt...
And Hayek is frustrated because this is an obvious and simple concept

So how do we fix this?

Simple answer: Get rid of student loans

Not-so-simple short-term result: Getting rid of student loans will cause a recession and a rapid decrease in college attendance.

Here is why

Keynesian Economics

Keynesian economics, named after the economist John Maynard Keynes, takes an approach that uses loans and artificially-low interest rates to stimulate the economy. As can be observed from above, this is exactly what causes the rapid increase of the cost of tuition.
F.A. von Hayek, a critic of Keynesian economics, explains how Keynes's approach to "boom" the economy will ultimately cause a "bust" or economic recession.

If getting rid of loans will cause a recession and lower college attendance, why do it?

The recession will only be short term in the same way the Keynesian approach to stimulate the economy is short term.

However, in the long run, college tuition will rise naturally. In addition, the quality of education will increase as universities will use academics and scholarships to attract students rather than fancy dorms or great sports teams. When companies have a demand for an employee in a certain field (engineer, nurse, doctor, etc.), they can provide scholarships for students pursuing those degrees.

Created By
Michael Bagnasco
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Created with images by CresySusy - "Economics"

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