Warsh's Jackson Hole Speech: Betting on AI to Aid Labor, Inflation Still Critical

**SPEAKER_1** (0:00)
Now, I'm pleased to say we are joined by Orphe Divounguy, who's the founder economist of the Quantitative Research Group. Orphe, thank you so much for your time. What were your biggest takeaways from Mr. Warsh and what he just said?

**Orphe Divounguy** (0:12)
Well, yeah, thanks for having me. What I heard was innovation and policy will help bring inflation back to target.
But then he admitted that the economy is changing faster than the old models can comfortably explain. Look, AI could raise productivity and ease inflation, but we don't know yet how large the gains are going to be or who will receive them. And because the Fed doesn't know that future either, it shouldn't over promise a path for interest rates. He wants a quieter Fed, a more modest Fed. But I also heard him making a big supply side bet. Labor force growth is weak, so if the economy is going to keep growing without generating more inflation, productivity has to do more of the work. AI being the obvious candidate, right?
We're seeing the investment boom, but we're not seeing the productivity payoff just yet.

**SPEAKER_1** (1:04)
Well that's it. And it's interesting how he sort of started off by talking about AI, LLMs and tokens. I mean, that was a very different speech to perhaps what we're used to. And I guess he has to touch on it because he has been quite explicit in talking about the US being on the precipice of this sort of productivity boom that's sort of been led by AI, which he ultimately think will be deflationary. But as you mentioned, I mean, he talked about the implications of this capital for monetary policy in the future.
But he did talk about the unknowns and a big question mark as to when we would start to see that productivity. What does that signal?

**Orphe Divounguy** (1:44)
Yeah, we're not really seeing it yet, right? The economy is on kind of, I would call it, two speeds. We are seeing a massive capital boom. Data center, chips, software, big finance at some of the highest real rates in years. So it's a big bet that AI will deliver a productivity payoff. It just hasn't shown up yet, right? In Q2, equipment and IP investment accounted for roughly 80% of Q2 GDP growth. And yet, productivity growth slowed last year from 1.5% to 0.8%, even as AI spending surged. If AI delivers, great, faster productivity can let the economy produce more without generating more inflation, lift real incomes and make today's real rates, make today's debt load easier to service. But if AI disappoints, higher real rates become much harder to carry for households, businesses and even the federal government.
At the same time, we're seeing this capital boom, but we're also seeing real incomes have barely grown from a year ago. Households are spending out of savings and borrowing at a higher rate. You know, and interest rate sensitives, like housing, are really struggling right now.

**SPEAKER_1** (2:57)
Yeah, and I know you spent some time at Zillow, so you know a few things about the housing market. I mean, his assessment, though, of what's happening today in the economy, Orphe, I mean, he seemed to be impressed by the performance. He said the labor market is stable. He did point out that the housing market is showing strains, but he said he would be hard pressed to describe broad financial conditions as restrictive right now. So where do you think that leaves his calculus about, you know, fixing the struggling housing sector?

**Orphe Divounguy** (3:27)
Look, the entire yield curve has moved up. The two-year moved up. The 10-year treasury moved up. The 30-year recently traded above 5.3% around levels not since 2007
It means rates on everything from credit card to mortgage rates and corporate borrowing costs remain restrictive, right? Without a rate hike, right? And so I think Warsh is getting the restraint coming from the bond markets. And that's probably also why he didn't, you know, the Fed hasn't raised rates this year, right? You know, we're in an election year. It's a time where the White House is calling for lower rates.
So I think that's got to be part of the calculus as well.

**SPEAKER_1** (4:11)
What do you make of the market reaction? I mean, you know, given that we did see that flattening of the curve, I mean, obviously, we're looking back to a coin toss essentially for that next meeting as far as the rate hiking expectations here. I mean, how hokish did you take this?

**Orphe Divounguy** (4:28)
It was, you know, the focus squarely on inflation.
The fact that he said the responsibility of 65 consecutive months of sustained and elevated inflation above the 2% target, right, stands squarely with the Fed. You know, I think that sounded very hawkish.