Fed Faces Mounting Pressure to Raise Rates Amid Resilient Economy and AI Boom

The Federal Reserve is under pressure to raise interest rates due to the resilient US economy and AI investment boom.

Despite leaving interest rates unchanged, the Fed faces growing criticism for not tightening policy soon enough. Kevin Warsh argues that tighter financial conditions and future AI-driven productivity gains reduce the need for immediate action, but consumer spending remains robust and AI investment continues to support growth.

The resilience of consumer spending is surprising, given higher energy prices and lower real labour income. Tax refunds have helped offset households' higher energy bills, but this cushion may not last if oil prices remain elevated.

AI investment is an important driver of nominal domestic demand, contributing 1.3 percentage points to the economy's 7.4% annualised growth rate in the first half of the year. Firms have raised prices and widened profit margins due to buoyant demand, explaining why inflation has remained above target for several years.

If AI investment remains resilient, the Fed may need to slow down other parts of the economy, with most Taylor-rule specifications already implying a policy rate above 4%.