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AI, Expectations, and Optimal Interest Rates

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Abstract

An AI productivity boom can warrant lower nominal rates even when most gains are anticipated. I derive analytical representations of optimal rates under commitment and discretion in an economy with sticky prices and wages and hand-to-mouth households. Holding the realized productivity path fixed, I vary expectations. Anticipated gains raise the natural rate, but below-target inflation supports real wages and keeps nominal rates lower. Surprises leave the natural rate unchanged, calling for cuts. After surprises, expected redistribution toward hand-to-mouth households calls for deeper rate cuts to sustain savers’ spending. Raising rates requires more anticipation when wages are stickier relative to prices.

Suggested Citation

  • Alessandro Villa, 2026. "AI, Expectations, and Optimal Interest Rates," Working Paper Series WP 2026-21, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:103965
    DOI: 10.21033/wp-2026-21
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    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E25 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Aggregate Factor Income Distribution
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes

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