Publicly disagreeing with Waller? Several Federal Reserve officials say: AI-driven productivity gains may mean a "higher neutral interest rate."

Several Federal Reserve officials have recently stated that the productivity growth brought by artificial intelligence may mean higher interest rates, a view that stands in stark contrast to the Trump administration and its Fed chair nominee, Waller.

Fed board member Michael Barr said in a speech in New York on Tuesday that he expects the AI boom is unlikely to be a reason to lower policy rates. He pointed out that factors such as capital demand and household savings may put upward pressure on interest rates.

San Francisco Fed President Mary Daly also said that day, under the "standard model," AI-driven acceleration in productivity growth would lead to a higher neutral interest rate because investment demand will rise relative to the supply of savings.

This analysis poses a challenge for investors expecting rate cuts. According to futures market pricing, investors currently expect the Fed will not cut interest rates before the middle of this year. After three rate cuts in 2025, the Fed kept rates unchanged at its January meeting this year, with the benchmark interest rate remaining in the 3.5% to 3.75% range.

Divergence with Trump's Camp Evident

Fed officials’ judgment on the relationship between AI and interest rates sharply differs from the view of the White House and its Fed chair nominee Waller. President Trump has continually pressured the Fed to lower borrowing costs. Waller echoes the administration’s officials, arguing that AI may unleash a productivity boom, leading to non-inflationary growth accompanied by lower rates.

However, a different view is forming within the Fed. Vice Chair Philip Jefferson stated in a speech on February 6 that, other things being equal, sustained increases in productivity growth may lead to a rise in the neutral rate, at least temporarily.

With Chair Powell’s term ending in May, issues of AI and productivity are expected to play an increasingly important role in this year’s interest rate debates.

Transmission Mechanism for AI Raising Interest Rates

Barr elaborated on several reasons AI may drive rates higher in his speech. He pointed out that utilizing this technology requires strong business investment, which will lead to an increase in capital demand, thereby putting upward pressure on interest rates.

In addition, as expectations of stronger actual wage growth and higher lifetime income increase, household savings may decrease, which will also put upward pressure on rates.

Mary Daly told reporters after an event in San Jose, California, that because investment demand will rise relative to saving supply, the acceleration in productivity growth driven by AI in the "standard model" would require a higher neutral rate. However, she also acknowledged that any analysis is far from definitive. "Maybe it will cause a modest rise in the neutral rate," she said. "We need to maintain a certain humility about the impact on the neutral rate."

Policy Shift Signals Emerging

The Fed has cut rates by a total of 175 basis points over the past 18 months, after raising rates by more than 500 basis points during 2022 and 2023. Currently, several officials believe the current rate level is close to the economy’s neutral level and cite this as a reason to slow or stop rate cuts.

Futures markets show investors currently expect the Fed will not cut rates again before the middle of this year. This expectation aligns with the Fed officials’ latest judgment about the impact of AI, suggesting monetary policy may maintain its current stance for a fairly long time.

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