Interest and Education

I have this idea that’s been in the back of my mind for maybe a year now, that involves the decision to prolong education and the influence of interest rates on that decision. I would be interested in comments on these ideas, as they are very undeveloped. Yesterday’s post on Production and Interest summarizes the basic theory behind an entrepreneur’s decision to either engage in production or lend. It turns out that the expected returns to each alternative will tend to equalize because of the effect of increasing or decreasing supply and/or demand in factor markets and credit markets. The decision to continue education is similar, but different.

The following train of thought assumes that students borrow to finance their education and that staying in school and working are mutually exclusive. A student can cease their education and supply labor on the market or they can continue their education and not only increase their future productivity, but also their specificity. Each option may be the opportunity cost of the other, so at some point, continuing education has diminishing returns and the opportunity cost–earning a wage–exceeds the benefits of staying in school and so the student leaves the education system for the workforce. If we assume that students borrow to finance their schooling, then low interest rates (not artificial) would encourage staying in school longer, getting more advanced degrees, and therefore becoming a more specific and productive future laborer.

Artificially low interest rates may have an ambiguous effect on students’ decisions to stay in school. Low interest rates make borrowing cheaper, but also increase the opportunity cost of staying in school because of the economy-wide propped-up wages induced by the artificial boom.

This still isn’t thought all the way through, but I imagine there is something to be said about malinvestments in the education system due to artificially low interest rates. Entire academic fields may get a “bump” or university administration salaries and positions may surge because of a combination of both monetary policy and government spending and regulation in education, just like other bubbles have been fueled and directed by similar combinations in the past (see housing and tech).

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