Impact of artificial intelligence on interest rates

Source-This post on Impact of artificial intelligence on interest rates has been created based on the article “AI could have a surprising effect on interest rates” published in “Business Standards” on 30 March 2024.

UPSC Syllabus-GS Paper-3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment & Awareness in the fields of IT, Space, Computers, Robotics.

Context-The author tries to understand the potential impact of AI on economies, asset prices and interest rates. As per the prediction of author, Real inflation-adjusted rates will go up in future.

How can boom in AI increase the interest rates?

1) The development of AI would require production of high-quality semiconductor chips. This requires a huge investment which will enhance the demand for capital expenditure (capex).

2) The productivity of capital is a major factor in shaping real interest rates. If capital productivity rises significantly due to AI, real interest rates will also rise.

3) If AI is integrated into lives and business plans, there will be higher demand for computation. This will require expansion of energy infrastructure. For ex- Northern Virginia is home to major data centers and with more deployment of AI, it will require large nuclear power plants to meet projected energy demands. All these expansions are costly.

4) As per the author, if AI made water desalination cost-effective in many parts of the world, then suddenly there would be more demand to develop water desalination plants in parts of California, Arizona and Nevada. The US would build more real estate and in turn will use more energy in the process. This would boost overall demand for investment.

5) AI-driven warfare and drone combat may rise in importance in future. This will encourage countries to invest more in this equipment.

6) Boom in AI may lead to job loss for millions of workers. This would require significant investments to help human workers deal with the resulting changes.Also,there may be an expansion of government programmes for worker assistance. So, all these and similar forces will put pressure on real interest rates.

Read more- Social and Political Impacts of AI

In the background of these trends, the author predicts that real interest rates will rise. Demand to borrow and invest will go up in future without a substantial increase in savings.

Question for practice

How can boom in AI increase the interest rates?