National announced yesterday that it is going to keep interest free student loans. As someone with a student loan I love the scheme and the free money it gives me. When I put my economist hat I think that it is terrible policy since it provides terrible incentives to for students to borrow. I personally didn’t have a student loan until they became interest free at which point I borrowed as much money as I possibly could.
Not only are National not avoiding electoral suicide by alienating students, they have also said they will provide a 10% bonus on early payments of more than $500 to help combat the fact that students have no incentive to pay back their loan while they are still in New Zealand (0% nominal rate=negative real rate due to inflation, i.e. your debt shrinks over time, isn’t that cool?).
Now this sounds nice on the face of it, but David Farrar has put on economist hat and worked out that while this improved incentives for repayment, it exasperates the perverse incentives regarding borrowing. DPF notes that an optimal strategy for a student would be to borrow as much as you could and then pay it off at the end of the year giving you a nice 10% return for your effort. However the problem is actually worse than that. Read more