Key Takeaways:
St. Louis Fed President Alberto Musalem said it would be a mistake for the central bank to count on AI-driven productivity gains to solve inflation, pushing back against a core Trump administration belief.
St. Louis Federal Reserve President Alberto Musalem said Thursday it would be a mistake for the central bank to ease policy based on hopes that AI will fuel a productivity surge and tame inflation, calling such a bet too risky.
"With the real policy rate sitting below the notion of long-run neutral, inflation running meaningfully above target, longer-term inflation expectations drifting higher and the labor market remaining stable, I believe it would be risky to rely on the prospect of higher productivity growth in the future to solve our inflation problem today," Musalem said in remarks prepared for a Central Bank of Iceland and Northwestern University economic conference in Reykjavik.
His comments come as the personal consumption expenditures price index jumped 3.8% in the 12 months through April, the fastest pace in three years and well above the Fed's 2% target. Core PCE, excluding food and energy, rose 3.3%. The Fed has held its benchmark rate in the 3.50%-3.75% range since its April 28-29 meeting, and financial markets expect no cuts until at least 2027.
Musalem's pushback directly challenges the view embraced by Fed Chairman Kevin Warsh and many Trump administration officials that AI-driven productivity gains will allow the central bank to set interest rates lower than would otherwise be necessary. If the Fed holds policy too loose based on that assumption, it risks allowing inflation to become entrenched, forcing sharper rate hikes later.
Musalem acknowledged that if evidence emerges that higher productivity growth is likely to ease inflation pressures, he would adjust his policy views. But for now, he said, the jury is out on how much AI will add to productivity, even as the pressures it is already putting on demand for chips and data centers are evident.
"Moving or holding policy rates too low could actually cause longer-term interest rates to rise," Musalem said, if the public questions whether the Fed will ever bring inflation back to the 2% target. "That would discourage investment and have detrimental effects on economic growth and employment."
He is the latest Fed official to push back on the AI-productivity narrative. Fed Governor Lisa Cook said Wednesday she is prepared to raise rates if inflation does not ease in a timely manner, citing tariffs, the Iran war and a surge in AI-related investment as price pressures. Chicago Fed President Austan Goolsbee has also noted that energy inflation has been more persistent than expected.
The Iran conflict has disrupted shipping in the Strait of Hormuz, boosting energy prices and straining global supply chains. The national average retail gasoline price shot up 12.3% in April and has increased more than 50% since the war started at the end of February, according to the U.S. Energy Information Administration.
A Divided Fed on the Path Forward
The divergence between Musalem and the Trump administration's preferred policy path sets up a potential clash at the central bank. Trump appointed Warsh as Fed chair with the expectation he would lower rates once the Iran war ends and energy prices ease. But a growing number of Fed policymakers have indicated they feel a rate hike could be needed. Minutes of the Fed's April 28-29 meeting showed a growing number of officials open to the possibility of raising rates.
The next Fed meeting is scheduled for June 9-10. OIS markets currently price the benchmark rate staying in the 3.50%-3.75% range through the end of the year, with no probability of a cut priced in before 2027.
This article is for informational purposes only and does not constitute investment advice.
