Monetary Policy in an AI-Driven Two-Speed Economy

Joshua Brault, Maryam Haghighi and Jing Yang

Staff Working Papers from Bank of Canada

Abstract: We study the monetary policy response to AI adoption in a two-sector New Keynesian model with a task-based microfoundation, sticky prices, and downward nominal wage rigidity. We distinguish between two forms of AI-driven technological change: augmentation, which raises the productivity of labor within existing tasks, and automation, which displaces labor by reallocating tasks from workers to machines, contracting the set of tasks requiring human input. In the short run, both shocks lower labor demand on net, and with downward nominal wage rigidity, unemployment emerges unless monetary policy provides accommodation. But because monetary policy operates through aggregate demand and cannot target sectors differentially, accommodation that reduces unemployment in the AI-affected sector raises inflationary pressure in the unaffected one, opening a sectoral wedge between the policy rates required to clear the two labor markets. Since, for output-equivalent shocks, automation generates a larger decline in labor demand, the associated wedge is wider and the Phillips curve lies above and to the right of the curve for augmentation---restoring full employment comes at a greater cost of inflation. In addition to the nature of the shock, the aggregate inflationary consequences depend on the breadth of AI adoption across the economy. Under augmentation, as the AI-affected sector grows, its falling sectoral price increasingly offsets the inflation generated elsewhere by monetary accommodation---making aggregate inflation an unreliable signal of the underlying trade-off. For automation both sectoral prices rise and no such offset exists. In our framework, sector-specific AI adoption poses an unambiguous short-run labor market stabilization problem, while its implications for aggregate inflation depend on the nature of technological change, the breadth of adoption, and the response of monetary policy.

Keywords: Monetary policy; Inflation dynamics and pressures; Monetary policy framework and transmission; Structural challenges; Digitalization and productivity (search for similar items in EconPapers)
JEL-codes: E E2 E24 E3 E31 E32 E5 E52 J J2 J23 O O3 O33 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2026-07
New Economics Papers: this item is included in nep-lma
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:26-27

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