An emerging policy narrative in fashion right now is that artificial intelligence will spur a productivity boom that will permit the Federal Reserve to lower interest rates more than would otherwise be the case.
While we agree that AI could lead to a productivity boom, it is entirely premature to think that such a change will create conditions in the near term for rates to be pushed lower.
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Consider total factor productivity, which measures how efficiently an economy turns labor and capital into output. Today, total factor productivity stands at 3.5%, which is well below the increases that took place at the dawn of the internet age from 1995 to 2004.
Perhaps AI will spur an increase in total factor productivity. At this point, though, a persuasive argument for rate cuts based on rising AI-driven productivity cannot be made.
Whatever productivity increases have been realized recently are a function of private sector investment made during the depths of the pandemic and its aftermath, and are not because of artificial intelligence.
Recall that during the pandemic, many younger workers opted out of the workforce. Many businesses acted rationally to increase investment on productivity-enhancing equipment, intellectual property and software. Those investments are starting to pay off.
AI is in the early stages of its deployment, as businesses start to figure out how to use it. If a productivity boom is coming from AI, it is just over the horizon.
Should productivity increase at the rate of economic growth, tax revenues will explode to the upside if, and only if, there are not significant disruptions in employment caused by the increase in total factor productivity.
Whatever the case, when one hears calls to lower rates now because of artificial intelligence, one should take those calls with a very large grain of salt.
