Chicago Fed's Goolsbee: Fed may need to raise rates if AI boom drives spending but not productivity

Chicago Federal Reserve president Austan Goolsbee cautioned Wednesday that amid expectations for an AI-led boom, if massive business investment and consumer spending occur before actual higher productivity shows up, the economy could overheat and the Fed might need to raise interest rates.

“It’s not at all obvious that the Fed would need to lower rates in that case. They might need to raise the rates in that case,” Goolsbee said on a panel at the Milken Institute conference.

“If it’s as good as it’s advertised, it … will make us rich,” he added. “But if that’s still to come in the future, I do think we need to be a little more circumspect and on the lookout.”

The increase in productivity growth and the possibility that it could be a lasting phenomenon and a boon to the economy are active areas of debate for the central bank and financial markets.

Some view the lesson of the 1990s as faster productivity growth can lead to lower rates because it lowers inflation. Incoming Fed Chair Kevin Warsh has argued that AI will boost productivity so much that it will push down inflation, allowing the Fed to lower rates.

Read more: How jobs, inflation, and the Fed are all related

Cathie Wood, CEO of investment firm Ark Invest, said on the same panel that she expects AI to boost real GDP by as much as 8% sustainably because of increased productivity from AI on what she anticipates will be “massive deflationary undercurrents.”

Goolsbee countered with a question: whether the boom is based on existing technology or on an extrapolation of recent improvements into the future. If it’s the latter, he said, there will be diminishing returns.

Read more: How the Fed rate decision affects your bank accounts, loans, credit cards, and investments

He gave the example of autonomous cars, in which it was predicted that autonomous driving would be so ubiquitous that every professional driver in the US would be out of a job within five years.

“It didn’t happen that quickly because, for what the improvements were, they were extrapolating that it would continue improving at that rate, and it didn’t. It hit diminishing returns,” Goolsbee said.

“So, I wonder when I see these massive data center expenses, how much of the improvement that we’ve seen so far is going to reach kind of the limits of growth,” he said.

Goolsbee said the economics suggest that the answer to raising or lowering rates depends on whether productivity growth is unexpected or anticipated.

In the mid-1990s, productivity had not shown up in the data when then-Fed Chair Alan Greenspan began arguing that it must be there to explain profit, employment, and inflation numbers.

Goolsbee said in that circumstance, lower interest rates were a natural response.

But if consumers and businesses expect productivity to increase in the future, he added, it can change their behavior today, making the rate picture more complicated.

“We need to keep an eye on the forecasts and expectations of how much of the productivity surge is still to come,” Goolsbee said. “The bigger the hype, the more rates would need to rise to prevent overheating.”

Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.

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