Warsh: AI-Driven Productivity Boom Could Accelerate Fed Rate Cuts

As AI Transforms the Economy, It May Alter the Fed's Policy Course

Kevin Warsh, a former Federal Reserve governor and one of ex-President Donald Trump's potential candidates for Fed Chair, argues that advances in artificial intelligence (AI) technology will create a "productivity boom" in the near future, profoundly impacting monetary policy. According to Warsh, AI-driven productivity gains will accelerate economic growth and create downward pressure on inflation. This dynamic could lay the groundwork for the U.S. central bank to bring forward its interest rate cuts to an earlier date than currently planned.

Greenspan's 1990s Thesis Revived in the AI Era

Warsh's analysis is seen as a reflection of former Fed Chair Alan Greenspan's 1990s "productivity miracle" argument, which emerged with the proliferation of the internet and information technology, making prolonged high growth and low inflation simultaneously possible. During the Greenspan era, technological advances boosting productivity allowed the Fed to be more cautious with interest rate hikes. Warsh indicates that a similar process could repeat itself, potentially more powerfully, alongside the AI revolution.

Productivity Gains Could Change Inflation Dynamics

In economic theory, productivity increases typically alleviate inflationary pressures. The automation of business processes, optimization of decision-making mechanisms, and gains in resource utilization efficiency hold the potential to lower production costs. AI finding widespread application in manufacturing, logistics, service sectors, and white-collar professions could create a significant positive supply-side shock in the economy. This situation could facilitate the Fed's achievement of its long-standing inflation target, rapidly creating the conditions needed to lower the policy rate.

A New Guide Needed for Policymakers

Warsh's assessment suggests that central banks may need to recalibrate their economic models and policy frameworks. The traditional relationship between growth, employment, and inflation could be disrupted by AI's transformative effects. Policymakers must now consider how sustained productivity improvements from AI could allow for a more accommodative monetary stance without reigniting price pressures. This requires a forward-looking approach that accounts for technological disruption's non-linear impacts on the economy.

The debate highlights a crucial juncture for monetary policy. If Warsh's prediction holds true, the Fed might find itself cutting rates sooner and potentially more aggressively to avoid overly restrictive policy in a high-growth, low-inflation environment driven by AI efficiency. However, uncertainty remains regarding the timing and magnitude of this productivity surge, leaving central bankers with the complex task of distinguishing between cyclical trends and structural shifts.