Fed's Barkin says AI lifts neutral rate as policy stays at 5.25%

Richmond Fed President Thomas Barkin said artificial intelligence investment is pushing up the neutral rate of interest, a shift that could keep monetary policy restrictive for longer as inflation shows signs of stickiness.

Richmond Federal Reserve President Thomas Barkin said surging AI-related capital spending is putting upward pressure on the neutral interest rate, a dynamic that may force the central bank to keep borrowing costs at 5.25% for an extended period.

"The investment wave we're seeing in AI infrastructure is having a real effect on r-star," Barkin said, using the term economists use for the neutral rate. "That has implications for how we think about the stance of policy."

The remarks come as the Fed's preferred inflation gauge — the core PCE deflator — climbed to its highest level since 2023, according to data released this week. Fed Governor Lisa Cook said May 27 she is prepared to raise rates if price pressures persist, joining a growing chorus of officials warning that the inflation outlook has deteriorated. The fed funds rate has stood at 5.25% to 5.50% since July 2023, and OIS markets now price a diminished probability of cuts in 2026.

The neutral rate — a theoretical level at which policy neither stimulates nor restrains growth — has become a flashpoint in Fed debates. If AI-driven demand for capital keeps r-star elevated, the current policy rate may be less restrictive than officials assume, meaning they would need to hold steady — or even hike — to achieve the same tightening effect. The next Fed meeting is scheduled for June 16-17.

Barkin's comments add a structural dimension to what had been a cyclical debate about inflation. Unlike tariff-driven or energy-driven price spikes, which tend to fade as supply chains adjust, AI investment represents a sustained demand for capital that could keep the neutral rate higher through the cycle. Economists at the San Francisco Fed estimated r-star at around 0.6% in real terms before the AI investment surge, but several Wall Street firms have since revised their estimates higher.

The shift has direct implications for risk assets. Higher-for-longer rate expectations have pushed the 2-year Treasury yield up 15 basis points over the past month to around 4.35%, while the S&P 500 has retreated 2.3% from its May highs. Technology stocks — the primary beneficiaries of AI enthusiasm — face a dual headwind: the promise of AI-driven earnings growth on one hand, and the reality of higher discount rates on the other.

The last time a Fed official explicitly linked structural investment trends to r-star was in 2023, when then-Governor Philip Jefferson noted that fiscal spending was pushing up neutral rate estimates. That observation preceded a period of elevated long-term yields that persisted for six months.

New Fed Chair Kevin Warsh, who took office May 22, inherits this debate. Warsh has signaled a return to strict 2% inflation targeting and has not ruled out rate hikes if inflation expectations continue to climb. The CPI currently stands at 3.3%, well above the Fed's target.

This article is for informational purposes only and does not constitute investment advice.