Source: Golden Ten Data
You only know that AI brings ups and downs, but you don't know how it will affect the central bank's interest rate level?
As artificial intelligence (AI) advances at an alarming rate, questions about how AI will affect the economy, asset prices, and interest rates also arise: is AI more likely to make them rise or fall?
AI will cause real interest rates to rise
Both macroeconomics and artificial intelligence are complex, making this question really difficult to answer. Despite this, Tyler Cowen (Tyler Cowen), an economics professor at George Mason University in the US, gave a bold prediction:
Under the influence of AI, real interest rates adjusted for inflation will rise and will continue for quite some time.
If this is true, the Fed's interest rate cut will be reduced, but the long-term benefit is that when the economy is impacted, the Fed will have more room to cut interest rates and ease. In the latest bitmap in March, Federal Reserve officials raised their forecasts for long-term interest rates, which may indicate that they think the US economy can already withstand higher interest rates.
According to the traditional view, interest rates tend to fall as wealth increases and productivity increases, and real interest rates have indeed generally shown a downward trend in the past 40 years. This is because, in theory, loans become more secure over time, especially as the wealth available for savings continues to grow, so interest rates don't need to be that high.
However, Professor Cowen's opinion is contrary, and he believes that artificial intelligence may change this trend. He gave two reasons.
Interest rates are declining, but AI could change everything
First, from a practical point of view, if there is a real AI boom, or if general artificial intelligence (AGI) actually becomes available, the demand for capital expenditure will be very high. Second, theoretically speaking, capital productivity is the main factor affecting real interest rates. If capital productivity increases significantly due to artificial intelligence, real interest rates should also rise.
How can capital expenditure drive up interest rates?
Driven by the AI boom, corporate capital expenditure will increase dramatically. These investments are neither easy nor cheap, but demand for investment will certainly not stop there; competition for capital will push up real interest rates.
As the AI “arms race” heats up, Nvidia CEO Hwang In-hoon predicts that the world will invest $1 trillion over the next four years to upgrade AI data centers. Dell'Oro Group's research also supports this view, and data center capital expenditure is expected to reach $500 billion in 2027. According to IDC data, the total global investment in AI in 2022 is US$128.8 billion, and is expected to increase to US$423.6 billion in 2027, with a CAGR of about 26.9% over the next five years.
The point is, we're probably just seeing the beginning of a rise in capital spending. AI is already making progress in driving the pace of scientific discovery, and this trend is expected to continue.
For example, if AI can help seawater desalination become more efficient and less expensive, then demand for increased coastal development will increase dramatically, such as California in the US. At that time, it will definitely be necessary to build more real estate and use more energy in the process. Saudi Arabia, the UAE, and many others are likely to do the same, further boosting overall investment demand.
Demand for space travel and satellite launches also appears to be rising, partly due to AI. Software innovation is driving huge advances in hardware. What is less optimistic, however, is that the importance of AI-driven warfare and drone combat is likely to rise, and recent developments in Ukraine and the Middle East speak for themselves. Although this is bad news, it will still drive further investment.
How can increased productivity drive up interest rates?
By increasing the efficiency of cognitive or knowledge workers, AI will directly increase the level of output in the economy. The Brookings Institution calculated in a report that if generative AI increases the productivity of knowledge workers by 30% over the next ten years, and this type of work accounts for 60% of the economy, then this would mean an 18% increase in overall productivity.
More importantly, if knowledge workers innovate more efficiently, they will be able to invent new things or new ways of working faster, thereby continuing to increase future productivity faster.
Moreover, if general artificial intelligence were to be realized, it would be equivalent to billions of workers entering the global economy almost simultaneously. In a relatively short period of time, it could increase US GDP by 5%, or bring in more investment to help human workers cope with the resulting adjustments.
When productivity increases, households save less because they know they don't need to plan ahead. Also, as society ages, people will gradually spend their accumulated wealth.
Demand for borrowing and investment continues to rise, yet savings may not increase accordingly. This means less capital available for investment, higher interest rates, and companies will invest only in the most promising projects.
Be alert! Real interest rates aren't just falling
But, as I said before, macroeconomics is never simple. Therefore, all of Professor Cowen's opinions should be viewed as speculations rather than predictions. Still, it makes sense to be prepared to reverse the long-term trend of falling real interest rates — at least for the next few decades, until AI-driven advancements create more wealth to supplement savings and lower real interest rates again. Although interest rates have been declining over the past few decades, this is not necessarily an iron law in economic history.
Just as the 2007-08 financial crisis proved that “great stability” is only an illusion, the current “big stability” — where real interest rates are declining and low, may just be an intermittent phenomenon.
edit/lambor