Introduction
In any conventional economic system, interest rates have great relevance. It is because interest rates affect the demand for loans and size of investment in an economy. A large component of any monetary policy, whether expansionary or contractionary, is the interest rate. The central bank adjusts interest rates when deems necessary, to realize different objectives, which could be purely economic objectives or they could be political-economic/social-economic objectives (CBN.Gov, 2017).
From this information, it becomes apparent that interest rates correlate with loans; when interest rates dwindle (expansionary monetary policy), size of investment increases in an economy. It implies that both investment and loans have a negative correlation with interest rates; when interest rates will decline, demand for loans will swell and thus investment. In a contrasting scenario (contractionary monetary policy), when interest rates increase, demand for loans or funds decrease and thus the size of investment in an economy (Serletis, 2013).
In recent decades, global financial markets have expanded dramatically, which have not only affected supply and demand dynamics, but also it has facilitated the entry of a new type of buyers and lenders. For instance, an education in the United States became more expensive, especially on college and university, demand for an educational loan also expanded. The rationale for acquiring an educational loan is that students consider education as an investment; more quality education they acquire, brighter are their chances to land a high-paying job. Therefore, students, who see student loan as a mean to realize their corporate dreams, aggressively seek student loans.
Statistics
According to the statistics, the market size, of student-loan, is around $1.4 trillion (Kelly, 2017). It is a huge market, and because of its sheer size, it attracts investment. However, financial experts are extremely speculative of the stability of $1.4 trillion markets. They assert that market is inherently flawed and because of its inherent dichotomy, it would eventually collapse. This plausibility of collapse also attracts investment, as some companies are willing to bet on the stability of the student-loan market.
According to the projections, the student-loan market will continue to expand, until the bubble burst, which will put both American and Global economy under tremendous pressure.
Reason for the Increase in Interest Rates on Student Loan and Mortgages
From the scrutiny of the literature, we have identified and isolated two reasons, which are primarily responsible for the increase in interest rates on student loans and mortgages. These reasons aid us in understanding that 1) why the size of the market is expanding and 2) interest rates are increasing at such pace. A thorough analysis of these reasons would also allow us to conclude the stability of the market and the future of student loans.
Demand and Supply
The expansion of demand is one of the two reasons for the increase in interest rates. It is evident, from statistical evidence that the number of students has increased in the United States. It is also apparent that education, of college and university, has also become expensive, which has pushed students to acquire loans for their studies.
As the number of students has increased; therefore, the number regarding the student loan has also swelled. It is a known economic fact that when demand for any commodity shifts to the right, it increases the price of that commodity. If we consider the loan as a commodity and interest rate price of that commodity, which a student has to pay in intervals, then the cause of the increase in the interest rate becomes apparent to us. Financial experts project that, as demand for student loans shifts further to the right, there will further increase in interest rates (on student loans and mortgages).
Bad Loans
Student loans are also considered bad or dirty loans because it is generally believed that most of the students cannot return the loan. The reason for that is that this perception that quality education will land them on the lucrative job is a flawed perception. Employment and wages (both nominal and real) are generally affected by overall economic conditions. For instance, when the economy is in an upswing, it produces lucrative corporate opportunities; however, when it is in crisis (down-swing), it not only fails to produce lucrative opportunities in large numbers but also adversely affects nominal wages. Therefore, financial institutions offer educational-loans on high interests.
Implications for financial institutions, students, and economically
Financial institutions, of capitalist economies, are considered greedy and reckless. For instance, economists blame the greed of Wall Street main cause 2007 economic crisis (sub-prime mortgage crisis), which jolted not only the American economy, but also the global economy. Some economies continue to mitigate the ramifications of the 2007 economic crisis, which was dubbed as
The Great Recession
Economists assert that financial institutions are about to create another economic crisis by expanding loan market, which is highly vulnerable and inherently flawed. On higher interest rates, financial institutions (such as private banks) continue to offer student loans that are creating a bubble similar to the housing bubble.
Student loans are yielding a variety of challenges for students as well. Not only students will be paying higher interests for longer periods, but also, they would be under tremendous stress because of the paying schedule. Also, a good portion of their income will evaporate in the form of loan installment, which will adversely affect the quality of their life.
Conclusion/Recommendations
In the end, it can be concluded that for an economy, not only the collapse of loan market will yield challenges, but also its existence. For instance, when a large portion of income, of individuals, will evaporate as a loan installment, size of consumption in an economy will reduce, which will keep a government and the Federal Reserve from realizing the objective of stable economic growth. Therefore, the student loan market must be reformed to make it more stable, and Federal Reserve must take measures to reduce the risk associated with student loans.
References
CBN.Gov. (2017, December 1). How Does Monetary Policy Affect Economic Growth? Retrieved May 3, 2018, from https://www.cbn.gov.ng/Out/EduSeries/Series11.pdf
Kelly, K. (2017, February 9). Investing in the Pain of Student Debt Is a Tough but Tempting Play. Retrieved from The New York Times: https://www.nytimes.com/2017/02/09/business/dealbook/investing-in-the-pain-of-student-debt-is-a-tough-but-tempting-play.html
Serletis, A. (2013). The Demand for Money: Theoretical and Empirical Approaches (2 ed.). Springer Science & Business Media.
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