CIBC’s Benjamin Tal and Helen Lao discuss how AI is affecting inflation, GDP growth and the policy challenge facing central banks, as near-term investment demand adds price pressure while longer-term productivity gains could prove disinflationary.
Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.
Benjamin Tal: Hello everybody. Welcome to CIBC's Eyes on the Economy podcast. I'm Benjamin Tal, Deputy Chief Economist, CIBC Economics. What is the real and ultimate measure of intelligence? It's what you do when you don't know what to do. And if that's the case, the next few weeks, months and quarters will test the economic IQ of every central banker in the universe because they the first to admit that they have no clue what's happening. We have this uncertainty regarding the Iran-U.S. war conflict. Nobody knows where energy prices will change, where they will go. This is a significant issue that is impacting the psyche of the market. We still have CUSMA, still have USMCA negotiations, and we don't know what will happen there. A lot of uncertainty happening. Our working assumption is that time is not on Trump's side. Our working assumption is that there will be some sort of compromise when it comes to Iran. Both sides are highly motivated to reach an agreement. And of course, when it comes to CUSMA, there will be some sort of arrangement. Tariffs are here to stay. But the question is how significant it will be for the Canadian economy. We'll discuss it in another time. But one thing we're sure of is that the AI revolution will continue to be with us for a long period of time. This is a certainty. And therefore, we have to try to figure out what it means for the macroeconomic story for inflation. We know that there are a lot of questions. To what extent the AI story is overestimated in the short term and underestimated in the long term. A lot of things we don't know. One of them is to what extent it's impacting the Canadian economy, not only in the next five minutes, but also the next 5 and 10 years. And that's something that my guest today joining us, Helen Lao, wrote a piece with Avery Shenfeld about the impact of AI on inflation, GDP, and what it means for the Bank of Canada. So Helen, let's start. Can you maybe try to explain how AI impacts inflation both in the short and the long term?
Helen Lao: Yeah, so AI actually can push up inflation in the short run, but it also has the potential to lower inflation in the long run. So think of AI's impact on inflation as playing out in two phases. Phase one, which is kind of where we are now, AI can actually add a bit of price pressure. And that's because it's driving a surge in demand for a relatively limited pool of inputs. That includes things like semiconductors, data center, and electricity capacities. And when demand rises faster than supply can respond, prices for those inputs tend to move higher, creating near-term inflationary pressure. But over time, the impact from AI on inflation should go the other direction. If AI helps firms automate routine tasks, improve logistics, and get more output from the same number of workers or hours, then productivity rises and unit costs should fall. That doesn't mean prices everywhere drop outright, but it can mean inflation runs lower than it otherwise would have. So AI should be somewhat disinflationary at this phase. But clearly that's not where we are right now, quite yet. Since AI's effect on inflation is also likely to vary by phase, the policy response may need to vary as well. And that's something I'm sure people at the Fed are thinking about that.
Benjamin Tal: Absolutely, this is extremely important. So short term inflationary, long term disinflationary, which is exactly what we are thinking about when it comes to AI and inflation. Now, let's go a bit more specifically. What components of inflation have been recently impacted by AI and what does it mean in terms of inflation?
Helen Lao: Yeah, so based on the literature, we identified two key components in PCE inflation in the US where demand has been lifted by AI projects. They are information processing equipment. That includes things like computers, software, and accessories, as well as electricity prices, because there are lots of anecdotal evidence that data center is driving up electricity prices because of the increase in usage. That cost is being shared by everyone along the grid. What we did to proxy the AI impact on these two components is just simply look at their current contribution to total inflation versus their long-run average contribution. And what we found is that the contribution from these components are higher than their historical average. And we attribute that to AI. And so that amounts to about 0.3 percentage point as of May. So AI's impact through these components I highlighted are pushing up inflation by about 0.3 percentage point.
Benjamin Tal: That's very interesting, but this is not the only inflationary aspect here because also with GDP, GDP is improving due to investment and that's inflationary. What can you tell us about that?
Helen Lao: Yeah, that's exactly right. The AI investment boom is contributing to higher GDP growth and that makes the US economy more overheated and prone to inflation. So, what we did to quantify this is adopted the approach used by the St. Louis Fed, and we accounted for contributions of AI-related categories in GDP. So that includes investment in information processing equipment, software, research and development, intellectual property products investment and data center structures investment. We then kind of net out the import contribution to meet that demand. So that's captured by the inflows of computers, peripherals, and parts. And the result is that the contribution of AI to real GDP growth has picked up from 0.1 percentage point in 2024 to 0.3 percentage point in 2025, and is projected to increase to about 0.4 percentage point in 2026. That increasing contribution is mainly due to AI investment, sort of investment in information processing equipment, as well as software and R&D. AI stocks are also primary driver of the global bull equity market in the last three years. This has contributed to increases in equities wealth owned by investors. So this would then indirectly boost consumption because higher wealth should translate into more spending powers by consumers. Based on the research on a marginal propensity to spend from equities wealth from the Fed and the share of AI stocks in the S&P 500 index, we estimate that AI equity's wealth effect on consumption should boost GDP growth by about 0.2 percentage point from 2024 to 2026 each year. Combined with our estimate of AI contributions from AI investment net of imports I mentioned before, this means AI contributes about 10% or 0.3 percentage point to real GDP growth in 2024, about 0.5 percentage point or 20% in 2025. And is expected to account for about 0.6 percentage point or close to 30% of GDP growth in 2026.
Benjamin Tal: Interesting. So if we put it together, how much is AI actually boosting total inflation in the US at this moment?
Helen Lao: Yeah, so the direct impact from AI related components in inflation, notably the information processing equipment and electricity, that's about 0.3 percentage point currently. And from the indirect impact on inflation, from the more overheated economy through a more positive output gap…So the difference between what the economy currently produced and what it could produce at full capacity. That's the indirect impact. Adding that indirect impact, we estimate that total AI's contribution to total inflation was only 0.1 percentage point in 2024, but has escalated to roughly 0.4 percentage points in 2026. 0.4 percentage point might not be big for a lot of people. And it means that even without the AI contribution, total inflation would still be above target. And right now, with inflation still sort of close to double the target rate, AI is really just one, but not the only culprit to the above target inflation. There are other factors such as higher oil prices tied to the Iran conflict that also played a role in the inflation being above target.
Benjamin Tal: Very interesting. So the Fed will have to figure out what to do. Our call is that the Fed will stay on the sidelines until the end of the year. The market is pricing in about 25 basis points. It's very difficult to call. It's a very difficult call, quite frankly, because of the impact of energy prices and how sustainable the conflict with Iran will be. Nobody knows, but that's something that the Fed will have to figure out. So I think that's it for today's episode. If you want more information, you can check out our website, the CIBC Economics website, and thanks for joining us. And until next time, we'll be keeping our eyes on the economy and calling it as we see it. Thank you very much and good luck.
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