'A hinge point in history:' Fed Chair Kevin Warsh lays out three variables the central bank will use to assess AI's effect on the economy

Enter Warsh. He has made no secret that he’s an AI enthusiast. Even before helming the Fed, he cast AI as a “disinflationary force” capable of turbocharging workers’ productivity and delivering a “significant increase” in their take-home wages in a Wall Street Journal op-ed late last year. He posited that a one-percentage-point increase in annual productivity growth would “double the standard of living in a single generation.”

Now Warsh is laying out the gauges that will affect how the Fed treats AI as it balances its dual mandate of stable prices and maximum employment.

What the Fed will assess on AI

Shortly after assuming the chairmanship at the Fed, Warsh announced the creation of a handful of research groups tasked with reassessing how the central bank executes monetary policy. One group was charged with studying how nascent technologies like AI are affecting productivity and jobs.

Warsh, a former investment banker, said that the Fed is well aware that AI is leaving its imprint on the economy. “We recognize that AI is a new variable — potentially a new factor of production — that will have consequences for both the economy and the conduct of monetary policy,” Warsh said in the speech, adding that “it opens some major lines of inquiry.”

Warsh listed several questions that policymakers will study as AI becomes entrenched in the US economy and beyond.

• “Will the application of AI cause a significant, sustained rise in productivity across the economy? And if so, when?”
• “Will token usage be complementary or competitive to labor?”
• “Will the next generation of AI models demand even greater capital intensity, or will the models themselves help devise a capital-light solution?”

So far on the first question, economists say there is a limited connection between productivity growth and AI. A group of economic researchers published a study in March indicating that U.S. sectors with higher AI adoption rates experienced larger productivity growth compared to pre-pandemic trends. But other factors could also explain productivity growth, including the rise of remote work.

AI tokens are the basic unit of AI interactions, or the computing power processed by AI on behalf of consumers and businesses. Many AI-curious companies, though, are slamming the brakes on their AI token spend since the final bill could run well into the six figures.

AI has popped up at Fed meetings more

The Fed’s next meeting is scheduled for mid-September, and investors are expecting the central bank to carry out its first interest rate hike of the year due to the elevated inflation resulting from the Iran War among other factors.

Members of the central bank’s rate-setting Federal Open Market Committee have repeatedly weighed in on AI’s economic impact this year. During its last meeting in July, Fed policymakers grappled with AI-related inflation, with “some participants” observing that the AI buildout has had “limited impact” on a small slice of the economy. Others assessed that it was already having a “broader effect on prices,” according to a public summary of the meeting.

Whatever comes next in the AI buildout, the Fed will be grappling with its effects for years to come.