Yardeni Research | Debating Warsh

💡Kevin Warsh argues for lowering the federal funds rate by asserting that a significant AI-fueled productivity boom acts as a powerful disinflationary force, allowing for faster economic growth without an increase in inflation. He believes this enhanced productivity means the economy can expand more rapidly while exerting downward pressure on prices, thus justifying more aggressive rate cuts.

💡According to Warsh, AI-driven productivity growth is a disinflationary force that allows the economy to expand more rapidly without increasing inflation. He posits that this increased productivity bolsters American competitiveness and challenges the traditional economic dogma that faster economic growth invariably leads to higher inflation, suggesting it should be discarded.

💡Some experts believe Warsh's view on interest rate cuts is flawed because, contrary to his argument, they contend that the productivity boom driven by AI will likely increase the neutral federal funds rate (R*) rather than decrease it. They also highlight that if the Fed lowers the federal funds rate below a rising R*, it risks fueling financial speculation, instability, and potentially prompting higher bond yields.

💡The neutral federal funds rate (R*) is a theoretical equilibrium interest rate where total savings equal total investment, neither stimulating nor restraining economic growth. It is a critical benchmark for monetary policy decisions; if the Fed's policy rate falls below R*, it risks overstimulating the economy, potentially leading to speculative bubbles and financial instability.

💡The historical link between a falling labor share of National Income and a declining neutral rate (R*) might be severed in the 2020s due to structural forces unique to the current decade. These include the Baby Boomer wealth drawdown, as this generation transitions from saving to spending their $89.6 trillion in net worth, and restrictive immigration policies, as working-age immigrants typically save at higher-than-average rates, both of which deplete national savings.

💡The Baby Boomer wealth drawdown significantly impacts national savings as this generation, which holds $89.6 trillion in collective net worth, shifts from being wealth accumulators to wealth spenders in retirement. This transition means they spend more than they earn, actively drawing down their accumulated assets, which consequently depresses the personal saving rate and acts as an upward force on R*.

💡Restrictive immigration policies affect the national saving rate by lowering it, primarily because working-age immigrants typically exhibit higher-than-average saving rates. By reducing the inflow of these individuals, such policies contribute to a drainage of the national savings pool, counteracting any potential savings glut from other economic shifts and putting upward pressure on R*.

💡Increased capital spending significantly influences investment demand and R* by creating an insatiable appetite for capital across all economic sectors. As firms vigorously invest in AI and other BRAIN technologies to automate operations, the competition for a finite pool of capital intensifies, naturally pushing up the price of that capital, thereby increasing both real economic growth and the neutral rate of interest (R*).

💡Jerome Powell maintains a stance of strategic patience regarding AI's impact on inflation and monetary policy, stating it is "too soon to know" if AI-driven productivity gains are structurally braking inflation. His focus remains on global uncertainties, including the conflict in the Middle East and its inflationary consequences, signaling that the current policy stance is appropriate until the 2% inflation target is more certain.

💡Structural forces pushing R* higher, specifically the decline in national savings due to Baby Boomer wealth drawdown and restrictive immigration, coupled with increased investment demand from capital-intensive AI buildouts, create a firm floor for long-term interest rates. This means the 10-year Treasury yield is anticipated to remain north of 4.00%, reflecting the true cost of money in an era of capital scarcity and robust investment appetite.