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Top academics have rejected Kevin Wersh’s claim that an AI-driven productivity boom would leave room for interest rate cuts, according to a snap FT poll of economists that highlights the challenges facing Donald Trump’s pick for Federal Reserve chair.
Warsh, whom Trump named his candidate to replace Jay Powell in late January, has argued that AI will trigger “the greatest productivity-boosting wave of our lifetime – past, present and future”. They say this would expand output and pave the way for the Fed to reduce US borrowing costs from the current level of 3.5-3.75 per cent without raising prices.
Nearly 60 percent of 45 economists surveyed by the University of Chicago’s Clark Center for Financial Markets this week said any impact on prices and borrowing costs over the next two years is likely to be negligible – PCE inflation will moderate and the neutral interest rate will fall below 0.2 percent over the next two years.
“I don’t think (the AI boom) is a deflationary shock,” said Johns Hopkins University economist and former Fed official Jonathan Wright. “I don’t think – in the near term – it’s very inflationary.”
Nearly a third of respondents said the AI boom could also force the Fed to raise the so-called neutral rate – the one at which borrowing costs are neither rising nor weighing on demand.
Warsh, who must be confirmed by the Senate before replacing Powell in mid-May, has focused on the impact of AI on productivity.
But other economists – including some at the Fed – have argued that, for now, the effects of technology could increase demand and price pressures.
“Even if AI ultimately succeeds in increasing the productive capacity of the economy, the more immediate increase in demand associated with AI-related activity could temporarily boost inflation, not offset by monetary policy actions,” Fed Vice Chairman for Monetary Policy Philip Jefferson said at a Brookings Institution event on Friday, citing the impact of the data center construction boom.
Winning the support of the remaining members of the rate-setting Federal Open Market Committee on the prospect of a rapid AI-driven productivity surge could prove difficult, leaving Warsh struggling to cut rates on the scale Trump wants before the midterm elections in November.
The FOMC estimates there will be only a quarter-point rate cut this year, putting the benchmark rate above 3.25 percent — far higher than the 1 percent rate Trump has demanded to fuel the U.S. economy.
Warsh’s view that the Fed should shrink the balance sheet, which he has labeled “bloated”, may also clash with other US rate-setters.
The FOMC recently backed the decision to end three years of “quantitative tightening” policy, which took the size of the central bank’s stock of assets from $9tn to $6.6tn amid stress in currency markets.
Investors believe aggressively shrinking the balance sheet will drive up long-term borrowing costs, potentially driving up mortgage rates and leaving the White House worried that housing affordability will cost them the election.
However, more than three-quarters of respondents to the FT-Chicago Booth poll believe the Fed’s balance sheet should be less than $6tn two years from now.
“It is not unreasonable to shrink the balance sheet to some extent on a conditional basis, provided liquidity remains adequate and short-term funding markets remain stable,” said Harvard University professor Karen Dynan.
About the same proportion expect Warsh to succeed in its objectives, bringing the balance sheet closer to its pre-2008 size of $1tn.
The apparent contradiction between Wersch’s soft stance on cutting short-term interest rates and assertiveness on the balance sheet has raised question marks about how a man who has spent a lot of time criticizing the Fed – but less proposing solutions – will run the US central bank.
“The uncertainty is enormous,” said Jane Reingart of the University of Notre Dame. “It’s hard to say much about anything.”
Others emphasized the extent to which events could conspire for or against the former Fed governor’s world view.
“The AI boom could generate a booming economy, a shrinking budget deficit, higher neutral interest rates and a comfortable contraction in the Fed’s balance sheet,” said Robert Barbera, an economist at Johns Hopkins University. “Or we could experience a financial market crackdown, a deep recession, a dramatic increase to deficits, a return to zero short rates, a swoon for the dollar, and demand for another big dose of (balance sheet expansion).”
The majority of those surveyed did not support the Trump administration’s aim – which Wersch has supported – to deregulate the banking system, with just over 60 percent saying it would have little impact on growth in the near term but would materially increase the risk of financial crisis.
