AI, Expectations, and Optimal Interest Rates

Alessandro Villa
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Alessandro Villa: https://www.chicagofed.org/people/v/villa-alessandro

No WP 2026-21, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: An AI productivity boom can warrant lower nominal rates even when most gains are anticipated. I derive analytical representations of optimal rates under commitment and discretion in an economy with sticky prices and wages and hand-to-mouth households. Holding the realized productivity path fixed, I vary expectations. Anticipated gains raise the natural rate, but below-target inflation supports real wages and keeps nominal rates lower. Surprises leave the natural rate unchanged, calling for cuts. After surprises, expected redistribution toward hand-to-mouth households calls for deeper rate cuts to sustain savers’ spending. Raising rates requires more anticipation when wages are stickier relative to prices.

Keywords: Optimal monetary policy; Sticky-prices; Hand to mouth (search for similar items in EconPapers)
JEL-codes: D84 E25 E31 E52 O33 (search for similar items in EconPapers)
Pages: 22
Date: 2026-10
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedhwp:103965

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DOI: 10.21033/wp-2026-21

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