How will rising interest rates affect students?

Honi takes an interest.

With the Reserve Bank of Australia (RBA) raising the cash rate target by a combined 125 basis points in the last three months to 1.35 per cent, and just today raising it further to 1.85 per cent, Australians are seeing interest rate rises that outpace expectations, which mark a distinct departure from the monetary policy setting of the last two decades. 

The rise in interest rates responds to escalating inflation, with headline inflation (i.e. the overall increase in the prices consumers are paying for goods and services) sitting at 6.1 per cent in June and expected to rise further throughout 2022. The effects of inflation on students are obvious: our student debt increased by 3.9 per cent due to indexation last month, we have been paying over $2 a litre for petrol, rents inflated by 9.7 per cent between June 2021 and June 2022, and wages have lagged behind the growing cost of living.

The cost of living crisis is a complex story. Long-term COVID-19 related supply chain issues and rising petrol prices have increased costs for businesses, while skyrocketing energy prices worsen the situation. 

These external factors are exacerbated by policy decisions made by the Morrison government, which pumped billions of dollars into the economy before the Federal Election despite a rebounding economy with very low unemployment. Middle-class welfare, pork-barrelling and short-termist injections into the construction industry didn’t meaningfully increase productivity, but they did drive demand in the immediate term. 

Crucially, inflation is not in itself a bad thing: when real wages keep pace with inflation, it can be actively desirable. Indeed, the past decade of low interest rates sought to address consistently sluggish inflation. However, the current wave of inflation has largely been produced by price shocks and short-term spending, not increases in real wages.

Increasing interest rates are the key way the RBA can address inflation, although it’s important to note that the federal government can adopt fiscal policies that help to alleviate the problem too.

But what is the impact of interest rate rises on students?

The most immediate effect of interest rate rises is to make borrowing money more expensive. This aims to counteract inflation by reining in spending, since getting into debt costs more. If demand falls, increases in prices should slow.

Rent inflation to continue 

For people with significant debts like mortgages, this will increase the cost of repayments when they are not on fixed rates. That increase will also make it more difficult to get a loan. 

While most students aren’t taking out major loans, we are affected by the indebtedness of other participants in the economy. Most notably, students who rent are vulnerable to increases in mortgage repayment rates being passed on by landlords, worsening already-steep rent inflation. 

This could exacerbate the housing crisis, which has seen student rental accommodation become increasingly inaccessible, especially as university accommodation is sold off.

What will happen to unemployment 

High inflation is correlated with low unemployment, and we are indeed seeing historic low unemployment. 

Raising interest rates and attempting to rein in spending could come at the expense of employment, if declining borrowing and investment shrinks the job market. This means that, while current inflation puts pressure on students’ cost of living, anti-inflation policy could also hurt young people by making it harder to get a job.

A policy approach to inflation need not necessarily lead to unemployment — instead, we could focus on increasing productivity (for example, by investing in sectors with room to grow such as renewable energy) or redistributing the costs of inflation away from workers (for example, by applying windfall taxes to companies who are profiteering). 

Ensuring that low unemployment is taken seriously as a political goal will be essential to protecting young people’s interests with respect to inflation.

Interest rates and investment

Higher interest rates make borrowing money more expensive, impacting investment. 

While most students are pretty far removed from investment decisions, one way in which higher interest rates could indirectly affect young people is by posing challenges to investment in green industries – including renewables, green technologies and climate mitigation

As a newer industry, the establishment of renewable energy infrastructure and the development of green technology benefits from cheaper capital (equipment and infrastructure) costs. 

The cost of establishing renewable power plants has been found to be more responsive to low interest rates than that of fossil fuels, meaning that green industries are more competitive in a low interest rate economy. This is because the majority of costs associated with renewable energy is the setup, rather than ongoing operation and inputs.

Accordingly, policy support to direct investment towards green industries and maintain investor confidence in the sector might be necessary to support the energy transition and other environmentally beneficial activities. 

Inflation is a policy question

In the midst of all of these economic dynamics, it’s important to remember that inflation is not a neutral monetary phenomenon — government policy can influence the winners and losers from inflation, distributing who bears the costs and who experiences the benefits. 

Ultimately, how inflation and interest rate rises affect students depends on the decisions of our policymakers.