The Fed and AI: What Investors Should Think About for the Long Term

The Nobel Prize-winning economist Paul Romer once wrote that “economic growth springs from better recipes, not just from more cooking.” ¹

This is a key idea in economics: raising our standard of living is not just about adding more workers or more equipment. It is also about helping each worker produce more goods and services, and better quality ones too.

This idea is often captured by the word “productivity,” which simply means how much output a worker can produce. Productivity is the main driver of the kind of economic growth that raises wages and improves quality of life. It is also one of the most important questions right now, as the use of artificial intelligence (AI) continues to grow rapidly.

AI and Federal Reserve (Fed) policy might not seem connected at first glance, but they are. In the short run, both affect financial markets and interest rates. In the long run, they are linked through productivity and economic growth. Fed Chair Kevin Warsh recently spoke about these topics at the Fed's annual gathering in Jackson Hole, Wyoming. ²

Given how much AI has already affected markets in recent years, and the ongoing uncertainty about what the Fed will do next, what should investors keep in mind from a long-term point of view?

AI and long-run economic growth.

To understand why productivity matters, it helps to look at how economists think about growth. Basic economic models focus on workers and “capital,” a term for equipment, machines, and tools. But education and technology are just as important, because they help workers produce more using the same amount of capital.

Think of a restaurant: it can serve more meals if it has more cooks, better equipment, or better-trained cooks who know how to make the most of their ingredients. A more knowledgeable doctor with access to advanced equipment can deliver better results for patients. While economic models simplify reality, the core point is clear. Producing more and better output per worker, in any field, is what truly drives higher wages and better living standards over time.

This is why productivity growth matters so much, even though it is hard to measure precisely. What makes AI both exciting and difficult to predict is that it touches nearly all of these factors at once. Depending on how you look at it, AI can act like a worker, like a piece of equipment, or even as a way to create entirely new methods and technologies. Warsh, for example, framed this in his speech as a question of whether AI would be “complementary or competitive to labor.”

In science fiction, AI replaces workers entirely, especially those who work with information, such as data analysts or computer programmers. However, it is not yet clear that this is happening in practice. Current evidence suggests that AI may instead be another tool that helps workers get more done, much like the information technology boom of past decades. As early evidence of this, some companies are now rehiring workers they had previously let go because of AI. ³

The chart above shows that productivity growth has changed a great deal from decade to decade, but it tends to rise when new technologies are widely adopted. The economic expansion of the 1990s, for instance, came with a notable increase in output per worker, even though it took some time to show up in the data. ⁴

Inflation remains the Fed's focus

For now, the Fed is most focused on inflation, which means rising prices across the economy. The Fed's preferred way to measure inflation is the Personal Consumption Expenditures (PCE) price index. The latest reading shows prices rose 3.7% compared to a year ago, while “core” PCE (which leaves out food and energy) rose 3.3%. ⁵

Both figures are well above the Fed's 2% goal, and progress over the past two years has been slow, partly because of higher oil and gasoline prices tied to conflict in the Middle East. In the short run, this puts the Fed in a tough spot as it tries to support economic growth while also keeping prices in check.

Markets have been trying to predict when the Fed might raise interest rates, which has caused some turbulence recently. Right now, many expect at least one rate increase before the end of this year, and possibly two by the end of the first quarter of next year. These expectations can shift quickly as new economic data and Fed signals emerge, and they have already changed meaningfully over the past several months.

Over the longer term, however, the picture could look quite different, depending on how AI and other technologies develop. Technology tends to push prices lower over time, because it allows the economy to produce more goods and services of higher quality. If AI were to lift productivity significantly, the economy could grow faster and support higher wages, while keeping inflation more moderate.

It is also worth noting that many of today's inflation pressures come from specific recent factors, such as oil prices, data center construction, and semiconductor shortages. These drivers are somewhat separate from monetary policy and productivity trends, and could ease over time. That said, the process takes time and surprises can happen, so investors should be cautious about reading too much into any single inflation report.

The labor market is a key consideration.

At the moment, the job market signals that the economy is in good shape. While some sectors have seen layoffs, much of this reflects cost-cutting and the broader adoption of technology, not just AI specifically. Importantly, the unemployment rate (the share of people looking for work who cannot find it) remains historically low at 4.1%, and has been steady for the past two years. Wage growth has slowed, but at 3.1% year-over-year, pay is still growing at a solid pace by historical standards. ⁶

Why is unemployment so low even when job gains have been uneven? One reason is that the number of available workers has grown very slowly, due to an aging population and reduced immigration. The labor force participation rate (the share of people who are
working or actively looking for work) fell to 61% in July, near its lowest point in decades, as more people leave the workforce, including many baby boomers.

Restrictions on immigration have also slowed the growth of the available labor pool. When fewer new workers are entering the workforce, monthly job gains can naturally be modest, even as existing workers keep their jobs and companies hire when needed. This may help explain why initial jobless claims (the number of people applying for unemployment benefits after being laid off) remain near historic lows.

Across technology, inflation, and the job market, investors benefit from balancing short-term factors against longer-term trends. In the near term, markets face uncertainty tied to events such as the conflict in the Middle East and the pace of data center construction. Over the course of years and decades, productivity growth and broad economic trends are what will shape financial markets. Keeping a focus on long-term goals is the approach most likely to lead to financial success.

The bottom line? The Fed faces a difficult balance between inflation and the job market, especially as AI trends continue to develop. For investors, it's best to maintain a long-term perspective aligned with financial goals.

References

1. https://paulromer.net/economic-growth/

2. https://www.federalreserve.gov/newsevents/speech/warsh20260828a.htm

3. https://www.cnbc.com/2026/07/01/employers-who-laid-off-workers-for-ai-are-reversing-their-decisions.htm

4. https://www.bls.gov/news.release/prod2.nr0.htm

5. https://www.bea.gov/data/personal-consumption-expenditures-price-index

6. https://www.bls.gov/news.release/empsit.nr0.htm


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