How AI complicates things for the Fed
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Illustration: Aïda Amer/Axios
An epic capital spending boom is squeezing certain prices higher, while promising sharp productivity gains and potentially huge job losses. What's a central banker to do?
The big picture: The AI boom is likely to affect the appropriate monetary policy in multiple ways, with some effects pointing to higher rates and others toward lower. Those different impacts will play out on different timelines and with different magnitudes.
- It creates a gnarly set of crosscurrents and considerations, the resolution of which will likely prove to be the Federal Reserve's defining judgment calls in the second half of the 2020s.
- "Problematically, AI can realistically shift the economy in different directions over different horizons, reducing clarity on how monetary policy should respond," Tim Duy and Josh Lehner, economists at SGH Macro, wrote in a note.
Zoom out: President Trump's nominee to lead the Fed, Kevin Warsh, has argued that the massive productivity surge he anticipates from AI will allow rapid, non-inflationary growth.
- That would tend to justify lower interest rates than one might expect amid eye-popping GDP growth numbers.
- But there are also other ways the AI buildout and its ripple effects can impact the overall economy. And those may help shape the interest rate policy that best achieves the Fed's dual mandate of stable prices and maximum employment.
Zoom in: Higher productivity growth and capital spending tend to raise the neutral interest rate — the rate that neither stimulates nor slows the economy — due to higher demand for investment.
- That means that, all else being equal, the Fed should keep rates higher than they might otherwise.
State of play: The AI boom is also likely to have fewer theoretical impacts on the two sides of the Fed's dual mandate, inflation and jobs.
- The massive AI buildout is creating extra demand for electricity, semiconductors and construction inputs, and there's evidence it is contributing to near-term inflation, at least for certain goods and services.
- In Cedar Rapids, Iowa, employers want to talk about how "nobody can hire an HVAC person because data centers are absorbing all the people," Chicago Fed president Austan Goolsbee told reporters this week. "Stuff's getting expensive because they're competing for all the same factors of production, in economist-speak."
- At a time when inflation has been running above the Fed's target for five consecutive years, anything that further heightens those inflationary pressures, even if temporary, is unwelcome.
On the employment side of the Fed's mandate, if employers find far-reaching labor-saving results from AI technology, it could create a surge in unemployment.
- If that happens, Fed policymakers will have to decide whether they believe the job losses are part of a normal process of labor reallocating toward new jobs, which rate cuts can help speed along, or have created structural joblessness, which rate cuts can't do much about.
- A fear is that "our normal demand-side monetary policy may not be able to ameliorate an AI-caused unemployment spell without also increasing inflationary pressure," Fed governor Lisa Cook said in a speech this week.
The bottom line: With these enormous forces affecting the economy, it becomes nonobvious whether it means rates that should be higher or lower — and when.
