St. Louis Fed's Musalem Backs Rate Hike: High Inflation Should Not Be Tolerated for AI-Driven Productivity

Alberto Musalem, President of the Federal Reserve Bank of St. Louis, on Thursday (5th) joined several officials advocating for a rate hike in July, stating that under current conditions, the primary objective of monetary policy should be to effectively curb underlying inflation, rather than tolerate persistently high inflation in pursuit of future productivity growth.

The Federal Reserve (Fed) decided to hold interest rates steady during its meeting on July 28–29, but three voting members dissented, arguing for a rate increase. Several other officials have recently warned that if action is not taken promptly, inflation could become more entrenched, potentially forcing the Fed to raise rates more aggressively in the future.

Although Musalem does not hold a voting seat on the Federal Open Market Committee (FOMC) this year, he stated that he advocated raising the federal funds rate by 25 basis points at the July meeting. He also noted that the subsequent sell-off in U.S. Treasury bonds highlighted the importance of maintaining the Fed’s credibility.

Musalem’s main rationale for supporting a rate hike is the high probability that inflation will remain above the Fed’s 2% target over the next year or so if monetary policy remains unchanged. He added that another reason to act now is that “making gradual, small rate hikes earlier is less disruptive and less costly than being forced to make more drastic adjustments later.”

AI Can Boost Productivity, But Not a Justification for Tolerating Inflation

Some economists and Fed Chair Kevin Warsh believe artificial intelligence (AI) has the potential to enhance productivity and alleviate inflationary pressures in the long term. However, Warsh acknowledged after the July meeting that the timing of these benefits remains highly uncertain.

Musalem emphasized that while restrictive monetary policy might slow innovation and productivity growth, the Federal Reserve cannot take for granted the market’s confidence in its ability to control inflation.

He warned: “If markets believe the central bank is willing to tolerate above-target inflation simply because it hopes for a significant future productivity surge, it risks unanchoring inflation expectations. Once credibility is lost, the cost of rebuilding it will be very high.”

The U.S. will release its latest employment report this Friday, followed by a new round of inflation data next week. Musalem noted that the U.S. economy has continued to show resilience in recent months, with the labor market stabilizing, employment growing steadily, and the unemployment rate remaining close to its long-term equilibrium level.