AI could send interest rates higher

Chair Kevin Warsh says the FOMC will be militant on inflation. “We will deliver on the 2% inflation target,” he said in his press conference this afternoon. “There’s no walking back from our responsibilities.”

He also voted today to leave interest rates unchanged, despite inflation remaining far above 2%.

Why the dissonance? The best way to reconcile above-target inflation with an unchanged fed funds rate is to believe in AI. 

Warsh is a believer. “AI is going to make almost everything cost less,” he told CNBC last year. 

Not immediately, though. Warsh also says he expects that the current boom in AI capex will “increase measured prices” over the next year.

But he believes we should focus on what’s on the other side of these increases: an AI productivity boom that will lower prices.

In the long term, Warsh is confident that AI will be "structurally disinflationary" — like the internet once was, but more so.

“This is the most productivity-enhancing wave of our lifetimes,” he says, “past, present and future.”

Not everyone agrees that this will lower interest rates.

Higher productivity typically means the economy can grow faster without risking a surge in inflation (and therefore higher interest rates). But AGI promises something close to infinite productivity — machines that do virtually everything for us.

What might that do to interest rates?

A paper by AI researcher Caleb Maresca suggests the prospect of “transformative AI” (TAI) could set off a mad scramble for assets that would send interest rates soaring.

“Under baseline scenarios,” Maresca calculates, “one-year interest rates rise to 10-16%.”

16%!

That’s a big number — and it’s not because AI will cause GDP growth to be similarly big. “Evolving beliefs about TAI could create significant upward pressure on interest rates well before any technological breakthrough occurs,” Maresca writes.

Instead, Maresca theorizes that once people believe AI will automate much of human labor, they will race to invest, maximizing their claim on AI's future earnings before AI labor becomes the economy's primary source of income.

If AIs are the only ones working, the only way to make money will be to own a piece of the AIs.

It’s the race to invest in them that will drive interest rates higher.

Another academic paper, however, suggests this same prospect of machines replacing humans will drive interest rates lower.

“Transformative AI capable of automating most human labor can lower interest rates even as it dramatically accelerates growth,” the paper finds. 

This paper is also by Caleb Maresca!

The conclusion in his second paper is as dramatic as in the first, but in the opposite direction: “Under baseline calibrations, the risk-free rate falls to near zero despite growth rising from 2% to 11%.”

How could interest rates be 0% while the economy’s growing 11%?

A race to save.

“Agents who rely on their labor income and do not have access to risky capital markets,” his model forecasts, “increase their savings in a desperate bid to preserve purchasing power. This increased supply of savings drives down the risk-free rate to zero.” (Or lower.)

Maresca says his second forecast of interest rates at 0% does not invalidate his first forecast of 16%. “That paper and the present one bracket the range of theoretical possibilities.”

In other words, transformative AI could send interest rates soaring as people race to invest — or crashing as they race to save.

It’s hard to say!

Researchers at the Dallas Fed have come to a similarly bifurcated conclusion.

Their paper, modeling what a “technological singularity” would mean for per capita GDP, suggests there’s a wide range of possible outcomes for the effect of AI on the economy. 

The uncertainty was memorably captured in what may be the greatest chart in the history of economics:

In a benign version of the technological singularity, AI makes machines smarter at a rapidly increasing rate, eventually gaining the ability to produce everything, which leads to “a world in which the fundamental economic problem, scarcity, is solved.” That happy outcome is represented above by the red line.

In a “less benign version” of the singularity, however, “the machines become malevolent, and this eventually leads to human extinction.” That’s the purple line.

As the chart starkly illustrates, human extinction would mean that per capita GDP falls to zero.

And interest rates, too. 

Maybe.

— Byron Gilliam