IMF: AI Investment Puts Pressure on Global Interest Rates and Monetary Policy
SDG 8: Decent Work and Economic Growth | SDG 9: Industry, Innovation, and Infrastructure
Institutions: Reserve Bank of India | Ministry of Finance
The IMF Working Paper, From Servers to Rates: AI, ICT Capital, and the Natural Rate, investigates the macroeconomic effects of the growing wave of investment in ICT—including AI-related hardware and software—within the U.S. economy. The core challenge analyzed is the uncertainty surrounding how AI-driven ICT capital interacts with labor, as this relationship determines the future path of the economy and monetary policy.
The paper presents two contrasting scenarios that central banks must prepare for:
The first scenario is where AI acts as a helper by complementing labor. In this future, AI makes workers highly productive, leading to strong gains in output for the entire economy. However, this booming growth also causes a significant boost in demand, pushing inflationary pressure upwards. To prevent the economy from overheating, the theoretical safe interest rate (r*) rises, requiring central banks to adopt a tighter monetary policy (i.e., higher interest rates).
The second scenario is where AI acts as a replacement by substituting human labor. In this case, while efficiency may improve, the total demand for human labor declines, muting consumer spending. This subdued demand leads to less inflationary pressure. If this happens, the theoretical safe interest rate (r*) falls, requiring central banks to adopt a looser monetary policy stance (i.e., lower interest rates) to encourage investment and maintain economic activity.
If central banks misjudge AI’s labour effects:
Mis-judge AI as replacing labour → rates stay too high → recession risk
Mis-judge AI as boosting labour → rates stay too low → inflation spiral
The key takeaway for policymakers is the danger of guessing wrong, as failure to correctly assess AI’s role could lead to major policy errors, either causing out-of-control inflation or an unnecessary recession.
What is the Natural Interest Rate (r*)? → The natural interest rate (r*) is the theoretical real interest rate (adjusted for inflation) that supports the economy at its full potential, achieving maximum employment while keeping inflation constant. Central banks use this unobservable rate as a benchmark: if the actual policy rate is set below r*, the economy will accelerate and inflation will rise; if it is set above r*, the economy will slow down.
Follow the full paper here: From Servers to Rates: AI, ICT Capital, and the Natural Rate