Scarcely a day goes by when you don’t hear something about the potential for A.I. to usher in a productivity boom.
Overblown or not, it’s a nice thought. Particularly to the extent it’d be disinflationary at a time when some of the structural factors that contributed to decades of subdued price growth across the developed world are seemingly lost to the post-pandemic, wartime reality.
At the same time, another macro topic du jour — the r-star debate — revolves in part around the idea that a productivity boom would likely necessitate higher rates.
Those two dynamics aren’t contradictory, but as one reader pointed out in an email last week, they can certainly seem that way to the unordained. It was a good observation.
Happily, this was the subject of Morgan Stanley’s weekly “Sunday Start” piece (short missives on whatever’s top of mind for markets and macro).
Authors vary by week, but the latest installment came from Seth Carpenter. Below, find a trio of very short excerpts which address the interplay between the dynamics mentioned above — and a quick word on the medium- to long-term implications for equities.
By Seth Carpenter:
Over time, we will learn how A.I. gets deployed, in which industries, and over what time horizon the benefits are realized. For employment, I continue to be skeptical of the gloomy prognostications that a myriad of workers will lose their jobs to new technology. Economies evolve, and the advent of the lightbulb has not left a lingering horde of unemployed candlemakers.
Across various applications, there will be some net increase in meaningful and measurable productivity [from A.I.], allowing the economy to produce more at lower cost. The result eventually would be a disinflationary impulse. For now, the Fed is working on bringing inflation down through restrictive monetary policy — A.I. or not. And since the productivity gains will only play out over time, we can think about the period after the Fed has restored price stability. Will inflation fall back below target? Only until the Fed sees the disinflation happening, and then it will want to ease policy to take up the slack created by a more-productive economy.
While the disinflation from rising productivity should first lead to lower policy rates, over time, if productivity gains are large and sustained, we should actually see higher policy rates. The greater productivity is, the greater the incentive to invest. To keep the economy in equilibrium with rising productivity takes higher interest rates. And if the higher productivity growth is expected to last for some time, the higher rates should be reflected across the entire yield curve. Further, because the higher rates would be driven by fundamentals and not inflation, the entire real yield curve should rise. But, instead of seeing higher real rates as a negative for equities, faster productivity growth means that both earnings and real rates can rise in tandem — a shift in a correlation that many in markets have become used to.
Great points made.