Business Standard

AI could have a surprising effect on interest rates

You might think economists would have a simple handle on such a straightforward query, but the both macroeconomics and AI are complex

Artificial Intelligence, AI

Photo: Bloomberg

Tyler Cowen
As improvements in artificial intelligence (AI) continue apace, so do questions about how AI will influence economies, asset prices and — the question of the moment — interest rates: Is AI more likely to make them go up or down?

You might think economists would have a simple handle on such a straightforward query, but the both macroeconomics and AI are complex. Nevertheless, I have a bold prediction: Real inflation-adjusted rates will go up, and for a considerable period of time.

The conventional wisdom is that rates tend to fall as wealth and productivity rise. It is easy to see where this view comes from, as real rates of interest have been generally falling for four decades. As for the theory, lending becomes safer over time, especially as the wealth available for saving is higher.

My counterintuitive prediction rests on two considerations. First, as a matter of practice, if there is a true AI boom, or the advent of artificial general intelligence (AGI), the demand for capital expenditures (capex) will be extremely high. Second, as a matter of theory, the productivity of capital is a major factor in shaping real interest rates. If capital productivity rises significantly due to AI, real interest rates ought to rise as well.

Think about capex in a world of AI. The scurry to produce more high-quality semiconductor chips will continue. Those investments are not easy or cheap. But the demand for investment will not stop there. The more that AI is integrated into lives and business plans, the higher will be the demand for computation. That will induce a significant expansion of energy infrastructure.

Again, those are not cheap investments. Northern Virginia, for example, is now facing a major dilemma along these lines, and not only because of AI. The region is home to major data centers, and now needs the equivalent of several large nuclear power plants to meet projected energy demands.

And that could be just the beginning of the rise in capex. AI is already driving some advances in the pace of scientific discovery, a trend that can be expected to continue. Imagine, for instance, if AI made water desalination cost-effective in many parts of the world. All of a sudden there would be more demand to develop more parts of California, Arizona and Nevada. The US would build more real estate, using more energy in the process. Saudi Arabia, the UAE and many other places might do the same, boosting overall demand for investment yet higher.

Demand for space travel and satellite launches seems to be rising as well, partly because of AI. Software innovation is driving a lot of progress on the hardware side. Less optimistically, AI-driven warfare and drone combat may rise in importance, as already is true in Ukraine and the Middle East. This is bad news that will nevertheless drive further investment.

If enough of these trends come together in a short enough period of time, then real interest rates can be expected to rise. Demand to borrow and invest will go up, although savings will probably not rise proportionately, at least not in the short run. As societies age, they are spending down their accumulated wealth.

If AGI is realised, it would be akin to the arrival of billions of potential workers into the global economy roughly at the same time. That is a complicated scenario. But it is plausible that, over a relatively short period, it could boost investment by 5 per cent or more of US gross domestic product. There would also be significant investments to help human workers deal with the resulting adjustments and reallocations of their efforts.

In practical terms: Expect a boom in the moving-van sector, as well as an expansion of government programmes for worker assistance. These and similar forces will place further upward pressure on real interest rates.

As I said, macroeconomics is never simple. So all this should be considered more a guess than a prediction. Still, it makes sense to be prepared for a reversal of the long-run trend of falling real interest rates — at least for several decades, until AI-driven progress creates more wealth to replenish stocks of savings, lowering real rates once again.

In the meantime, be ready for change. Falling rates are not necessarily an iron law of economic history. Just as the Great Moderation was proved to be an illusion by the financial crisis of 2007-08, so may be the current “great moderation” — of real interest rates — prove to be an intermittent phenomenon.

The writer is a Bloomberg Opinion columnist. 
© Bloomberg
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of or the Business Standard newspaper

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First Published: Mar 29 2024 | 11:05 PM IST

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