About the author: Mike Harris is the founder of Cribstone Strategic Macro and director of the Syracuse University Whitman School of Management London Program.
Markets are hugely enthusiastic about what coming AI-driven growth and President Donald Trump’s pick for the next Federal Reserve chair, Kevin Warsh, might mean for the economy. But their read on the situation is too simplistic.
A growth supercycle from the mass manufacture and deployment of AI robotics is coming, but it is years away. In the meantime, there will likely be significant white-collar job losses that could spark a recession.
Warsh’s conviction that rates need to fall means he is much better positioned to avoid a recession than the backward-looking, data-dependent Jerome Powell. But if an AI-related recession does indeed materialize, Warsh will probably be a much worse steward of the economy. That is because he is so wedded to shrinking the Fed’s balance sheet. (He has argued that lower interest rates and AI productivity gains will drive disinflation, giving him room to reduce the balance sheet.)
If Warsh’s disinflationary call on AI is right, fantastic. But, if post-rate cuts, there is a recession from AI-related layoffs, the Fed would have limited power to respond should Warsh remain ideologically opposed to reinflating the balance sheet. Quantitative easing has been a key tool for producing stimulus in the economy during modern recessions. Warsh seems unwilling to use that tool.
Another challenge for Warsh will be the nature of an AI-driven recession. Central banks aren’t used to dealing with a labor market that softens because of new technology rather than demand weakness. When employers cut jobs because of weak demand, they typically also become stingier with wages for those who remain employed. But in the case of AI, the scale of the immediate productivity uplift will likely drive decent white-collar wage growth for some time. Simultaneously, immigration crackdowns will support manual service wages.
Inflationary pressures from this wage growth may mean a rate-cutting Fed overcompensates with more aggressive balance sheet cuts to sustain credibility. Wage strength will also make it especially difficult for the Fed to spot the point at which job cuts risk tipping the economy into recession.
If the U.S. does tip into recession, too much Fed balance-sheet cutting will become a hindrance for economic recovery. There will be limited room for rate cuts or higher budget deficits. Coupled with Warsh’s likely refusal to reinflate the Fed’s balance sheet, the U.S. economy could struggle more than it needs to.
This could all change when the U.S. eventually sees a broad adoption of AI robotics. But manufacturers are likely to only gradually make the sizable investments required to transition to industrial robotics. Credible mass market service and consumer AI robots are years away. So an AI robotics growth boom will probably be too late to avert a white collar AI driven recession.
Luckily, Warsh’s willingness to deliver rate cuts, even in the face of inflationary pressures, may be exactly what the economy would need to moderate the inevitable recessionary pressures that will come from AI-related white collar layoffs. The big question for markets is will Warsh’s foresight on the economic impact of AI be clearsighted, or will the ideological monetarist in him take advantage of the initial AI driven wage inflation to overzealously shrink the Fed’s balance sheet?
If he opts for the former, Warsh will likely be a much better steward of the economy than Powell. If it is the latter, his reluctance to reverse course on the balance sheet could mean he is one white-collar, AI-driven recession away from being a liability for not just Wall Street, but Main Street as well.
