Fed’s Goolsbee warns productivity gains may fuel inflation

Investing.com -- Rising productivity may not lower inflation and could potentially increase it if businesses and households begin spending more in anticipation of future gains, Chicago Federal Reserve President Austan Goolsbee said on Wednesday.

Goolsbee's remarks set up a potential debate with incoming Fed Chair Kevin Warsh, who has argued that higher productivity reduces inflation. Goolsbee said that while lower inflation from companies producing more with less seems logical, the impact on interest rates remains under discussion.

When people expect productivity increases in the future, it can alter their current behavior, Goolsbee said in prepared remarks for a Milken Institute conference in Los Angeles. Households, companies and shareholders may anticipate rising income and wealth, leading to increased spending that could overheat the economy before productivity gains materialize. In such cases, interest rates would need to rise, he said.

"It's critical we be careful about activity driven by assumptions of future growth," Goolsbee said. "The bigger the hype, the more rates would need to rise to prevent overheating."

Former Fed Chair Alan Greenspan opposed rate hikes in the mid-1990s because productivity was improving and would ease price pressures. However, by the end of that decade, the central bank raised rates even as productivity gains continued.

Productivity is expected to improve as artificial intelligence technology spreads across businesses. These gains may already be reflected in record equity prices that support spending among wealthier households.

During his Senate Banking Committee confirmation hearing last month, Warsh did not specify how productivity improvements might affect interest rates. The former Fed governor said AI's impact on the economy's productive capacity may exceed its impact on demand, suggesting downward pressure on inflation.

"I don't claim to have perfect knowledge of how any of these are going to go, but I do have an intuition the pace of change is accelerating," Warsh told lawmakers. The impact on the economy's potential "could be considerably bigger" than the influence on demand as firms build data centers and increase electricity use.

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