The AI boom has handed the Fed an inflation problem that rate hikes may not fix

Federal Reserve Chair Kevin Warsh will be in San Francisco on Monday, Nov. 15, to talk about how artificial intelligence might affect the economy and, in turn, monetary policy. The event has been planned for a while — before the Nvidia fallout and the midterm election outcomes.

Still, AI isn’t going anywhere. The central bank continues to weigh just how much AI demand is responsible for current inflation.

Short term, there isn’t a lot of debate here: Investment in AI is boosting the price of chips, which in turn raises the prices of electronics including phones, computers and gaming consoles.

But that’s not all, said former Fed economist Ken Kuttner.

“We know that the AI buildout is putting pressure on the demand for labor, the demand for goods and services and in some places it’s actually raising energy prices,” he said.

Kuttner said the better question is whether inflation from AI demand is a short-term thing. The problem is, there’s not a lot of time to figure that out.

“It would be a much easier call now if it weren’t for the fact that we’re already well above the desired rate of inflation,” he said.

Plus, the central bank is dealing with a bunch of other problems that push up prices, like the war in Iran.

Another layer here? AI buildout is fueling the economy. Companies have big appetites to borrow and spend. And the AI-powered corner of the stock market means some consumers have big appetites to borrow and spend, too.

“It’s making many people very wealthy. And so they may be more likely to buy houses and consume,” said former Fed governor Randy Kroszner.

To slow consumption, the Fed is likely to raise rates in December. But Kroszner said it’s probably not going to curb AI spending.

“There’s so much excitement about AI that, you know, half a percentage point higher interest rates, not sure that’s really going to slow down AI investment,” he said.

This Nvidia scandal, the AI data center backlash, and the question of whether the sector is moving too fast, could put a speed bump in investment.

Still, EY-Parthenon Chief Economy Gregory Daco thinks AI will keep adding to the inflation soup.

“That’s likely to linger over the next 12 to 24 months,” he said, and help build a case for more interest rate hikes next year.