career prospects, or similar bad outcomes. in considering what the proper public role should be, it ’ s useful to think about an extreme case. in europe, higher education has traditionally been essentially 100 percent publicly funded. this result is big subsidies for people – mostly wealthy people – who would have gladly paid for college if they had to. making college free also means that there will likely be excess demand for the fixed number of seats at high quality institutions. either this demand has to be rationed, or quality will have to fall. neither choice is particularly attractive. in fact, excess demand and growing costs have put severe pressure on the european model for financing higher education, and european countries are now gradually moving away from the old system, introducing income - based tuition fees and loans to help restrain rising costs and expand access to higher education to more social groups. in the us, we ’ ve used a more complicated system that has several major elements. first, we have public universities whose tuitions are less than the full cost of providing the education, with the difference made up by state taxpayers. this can align the public and private benefits in the long run, but won ’ t by itself mitigate the liquidity constraints that families face. also, as i will discuss in more detail later, it puts public universities at the mercy of the business cycle. second, we offer pell grants to families with limited means to pay for college. we also use the income tax system to reduce the cost of attending up to four years of college for people with incomes below a certain threshold. these subsidies, which operate like vouchers since they can be used at lots of different colleges and universities, serve to align private and social returns and relieve liquidity constraints. because they are related to income, they also potentially have the additional important benefit of reducing inequality. the final major element of our system is loans. these relieve the liquidity constraint, but they don ’ t necessarily contribute to aligning the private and social returns to higher education. since student loans are currently receiving a huge amount of attention, and since the new york fed has been a leader in providing information about the sector, i ’ d like to spend the rest of my time discussing what i see as the main issues with student debt and what to do about them. bis central bankers ’ speeches issues with student debt student loans seem like a good part of the solution, but over the past decade our reliance on loans for funding higher education has increased and we are

severe revenue declines at the federal and state levels. being highly credit constrained, with university subsidies being part of operating budgets which must be funded with current tax revenues, many states cut planned education funding while allowing public universities to increase tuition levels. this in turn contributed to a significant shift of education cost to students and parents. in research conducted at the new york fed, we found that since 2007 those states with the largest funding cuts also had the highest tuition increases, with an average annual tuition growth rate of 3. 4 percent. as shown in chart 2, this compares to an annual average tuition growth rate of 1. 7 percent during the 2007 – 2010 period for all other states combined. that is, we observe an economically meaningful relationship between public funding and public institution tuition changes since 2007. higher tuition has forced many students to take on larger student loans. student debt and tuition increases were not limited to public institutions. research conducted at the nyfed found that over the same period there was even larger tuition and student loan growth at forprofit institutions. [ chart 3 ] despite larger average support through pell grants, with tuition national center for educational statistics, 2012. “ digest of education statistics ”. college board, 2013. trends in college pricing, last accessed february 5, 2015. bis central bankers ’ speeches levels more than double those at public institutions, average net tuition and average loan sizes were considerably higher at for - profit educational institutions. in addition, a much larger proportion of students at for - profits took out subsidized direct loans. [ chart 4 ] returning now to the surge in aggregate student debt, an increase in borrowing for college is not by itself a concern, given the high average lifetime payoff to college. in fact, in part the increase in debt reflects an arguably sensible increase in educational investment during a period of weak labor market opportunities. however, the growth in debt has important implications for the overall economy, and there are several worrisome aspects of the increase in student debt. many of these problems have to do with the high rates of delinquency and default on student debt, and the generally low repayment rates on these loans. over the past eight years there has been a considerable increase in payment difficulties for student loan borrowers. the most common measure of inability to meet the debt obligation is the proportion of borrowers 90 days or more past due on their payments. we refer to this as the “ measured delinquency rate. ” as of the fourth