``` The Federal Reserve's AI dilemma: Following Greenspan is a "dead end," not cutting rates is a "road to ruin." ```
The current frenzy surrounding AI is pushing the Federal Reserve into an unsolvable dilemma: following Greenspan is a "dead end," not cutting rates is a "hopeless road."
On November 28th, according to news from Wind Trader, globally renowned independent research firm TS Lombard said in its latest report that it remains uncertain whether AI will bring a deflationary productivity boom like in the 1990s or drive up the equilibrium interest rate (r*) due to huge capital expenditures. These two possibilities will result in drastically different monetary policy paths, which is the core problem currently facing the Federal Reserve.
Following Greenspan in cutting rates is a "dead end": Lowering rates simply because AI is expected to boost productivity, in imitation of Greenspan in 1996, would be extremely dangerous. Today's inflation environment is far less favorable than in the 1990s (when the core PCE inflation rate trended below 2%), and this approach completely ignores the historical lesson when Greenspan turned hawkish in 2000 for similar reasons.
If rates are not cut, it’s a "hopeless road": The Federal Reserve may unintentionally push markets into distress. The real risk is: if inflation returns as the top issue by 2026, the Fed will be forced to tighten policy. Even if they have no intention of pricking the bubble, a rate hike could be the last straw.
How will the Fed respond to the asset bubble triggered by AI? The report points out that Greenspan’s famous strategy is "clean, don’t lean", meaning not to deliberately pop bubbles, but to clean up the mess after they burst. It is foreseeable that his successors, especially a Chairman likely to be appointed by Trump and encouraging toward technology, will continue to follow this credo.
Greenspan's “double-edged legacy”: a complex policy template
According to the report, all potential candidates for Federal Reserve chair are trying to cast themselves as Greenspan’s heirs, claiming the AI revolution is an excellent reason to cut rates. They quote Greenspan’s famous decision from the mid-1990s:
Despite the unemployment rate falling below the so-called "natural unemployment rate" (NAIRU), Greenspan believed official statistics understated productivity growth, and used this to persuade hawkish colleagues to delay rate hikes.
The report states that in the autumn of 1996, Greenspan commissioned a study by Fed staff that “proved” productivity was seriously understated, especially in the services sector. In retrospect, Greenspan’s judgment was correct — newly revised data shows productivity growth in the 1990s did indeed far outpace official statistics at the time, with the annual productivity boost during the internet bubble contributing about 1.5 percentage points.
But that’s only half the story. By 2000, Greenspan’s attitude did a 180-degree turn. At the May 2000 FOMC meeting, he explicitly stated that sustained productivity boom had raised the equilibrium interest rate (r*), and the Fed needed to hike rates to prevent monetary policy from becoming excessively loose.
He believed that robust demand, driven by supply-side factors, must be balanced by higher long-term real interest rates. Ultimately, the Fed raised rates by 50 basis points at that meeting, accelerating tightening. This move, together with signals of insiders selling stocks, led to the eventual bursting of the dot-com bubble.
Thus, simply shouting “follow Greenspan and cut rates” is a selective reading of history. The “maestro’s” experience precisely reveals the Fed’s dilemma in the face of technological revolution: should it embrace deflationary effects, or beware of the potential for higher equilibrium interest rates?
Is AI a cure for deflation or a driver of inflation?
The report says the path by which AI impacts the economy is the key to determining Fed policy, but the direction is still hotly debated.
On one hand, AI may become a strong deflationary force. If productivity accelerates while wage growth is steady, unit labor cost will drop. Businesses can pass cost savings to consumers through lower prices. If new technologies increase market competition, firms will be forced to do so.On the other hand, the capital expenditure boom triggered by AI could drive up equilibrium rates. New technologies raise the expected return on capital, encouraging large-scale investment. If savings remain unchanged, greater investment demand means equilibrium interest rate (r*) will rise. If the central bank does not raise rates then, monetary policy will invisibly become too loose.
It’s worth noting that in the 1990s, wage growth outpaced productivity, and corporate profits as a share of GDP shrank after peaking in the mid-1990s, even as stock markets soared. This indicates workers, not firms, captured the benefits of productivity gains.
Three key issues decide the Fed’s policy path
The report points out TS Lombard believes the following three key questions will determine the Fed's policy path:
First, is large-scale capital expenditure in the tech industry inflationary?
Although companies like Nvidia create value, a huge amount of equipment is imported, and the resulting larger trade deficit could mask part of the inflation impact. Data centers are not labor-intensive, unlikely to overheat the labor market. The most obvious inflation risk is in energy — data centers consume massive electricity due to cooling systems.
U.S. data centers' share of electricity use is expected to rise from about 2% in 2005 to 12% in 2030. Overall, though, the impact of AI capital expenditure on raising equilibrium rates is limited, just another reason the U.S. economy can tolerate higher rates than in the 2010s.
Second, can AI bring about a jump in productivity like the 1990s?
Studies show AI can boost efficiency in tasks like programming by 40%, but only about 30% of economic tasks can deploy this technology. This means overall economic productivity would rise by about 12%, spread over the adoption period.
The key issue: only a small share of jobs rely on cognitive or knowledge-intensive work (construction, manufacturing, and professional services remain highly physical). Estimates on AI’s annual productivity contribution differ hugely: McKinsey predicts 4%, while MIT's Daron Acemoglu only predicts 0.5%. Replicating the 1990s productivity jump (annual increase of 1.5 percentage points) would be very hard.
Third, who will capture the gains from productivity improvement?
History shows workers, not firms, tend to benefit the most. In the mid-1990s, though Greenspan and Yellen worried that workers were being “traumatized” by digitization, wages rose rapidly and there was no mass unemployment.
AI’s “leveling effect” shows low-skilled workers benefit most — unlike the labor polarization in the 1980s and 1990s, when labor either “upskilled” into complementary sectors like finance or ended up in low-skill intensive jobs. AI is more likely to help the middle class and drive wages upward.
The Fed won’t deliberately pop the bubble, but could do so by accident
According to the report, Greenspan's “clean up after, not prevent before” strategy has become a Fed tradition. He believed central banks could not identify bubbles in real time, and trying to curb them with rate hikes would only cause unnecessary collateral damage to the broader economy (an extra 100 basis point hike would not dissuade investors chasing huge returns, but would hurt sectors without bubbles).
It is certain that a new Fed chairman appointed by Trump would not deliberately pop asset bubbles. But if inflation returns as the top issue in 2026, things will become subtle. The market focuses on the K-shaped economy, but if the lower part of the K recovers, there could be trouble at the top.
TS Lombard believes central banks have a habit of bursting bubbles, even if usually by accident. Current inflation dynamics are far less favorable than in the 1990s — core PCE inflation in the 1990s stayed below 2%, giving Greenspan room for loose policy.
This means attempts to “copy Greenspan” face higher risks, and while fighting inflation may inadvertently trigger a tech bubble burst — the biggest risk investors should be wary of.
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