Key facts
- AI boom acknowledged as contributing to inflation.
- Rate hikes may disproportionately impact credit-reliant sectors and consumers.
- Labor market not seen as a source of inflation through rising wages.
- Housing market already showing strains from higher borrowing costs.
- Stock market gains have been tempered, and activity outside AI has slowed.
- Inflation may fall without significant job losses if central bank credibility holds.
Federal Reserve officials are increasingly recognizing that the artificial intelligence boom is contributing to inflation, but the central bank's primary tool for combating price pressures—raising interest rates—may disproportionately affect sectors and consumers that are not part of the AI industry. Fed officials acknowledge that their policy of increasing borrowing costs lands unevenly, potentially impacting small and medium-sized businesses and consumers more reliant on credit, while AI firms continue to invest heavily. Nela Richardson, ADP Chief Economist, noted that with the housing market weak and the labor market not a source of inflation, the burden of cooling the economy may fall on small businesses and consumers. Cleveland Fed President Beth Hammack stated that higher rates could cool the economy 'at the margins' by tempering stock market gains and slowing activity outside the AI boom. Fed Chairman Kevin Warsh acknowledged AI investment as a 'shock' to prices and demand, though he believes wealth and productivity gains are on the horizon. Policymakers are debating the pace and extent of future rate hikes, with the Fed expected to keep rates steady at its upcoming meeting. Some officials, like Richmond Fed President Tom Barkin and St. Louis Fed President Alberto Musalem, believe inflation can be reduced without significantly harming growth or jobs, relying on central bank credibility to temper wage and price demands. However, factors like strong demand from AI-related industries, such as data centers, and potential price hikes by businesses with large backlogs present challenges. Potential disinflationary factors include a resolution to the Iran war lowering oil prices, a halt in tariffs, and upcoming fiscal policy changes. Nevertheless, the stock market outside of AI hyperscalers has not been robust, corporate earnings are not expected to be strong, and lower-income consumers may be nearing a spending pullback.