AI takeover: How the Fed's response would impact the economy

If the machines take all the jobs, expect the Federal Reserve to do whatever it can — which may not be much — to ease the pain of the resulting labor market realignment.The big picture: That is the implication of both the central bank's legal mandate and its past practice in times when economic growth was robust but the job market was weak.If demand for workers plunges because companies are able to replace employees with artificial intelligence, the Fed would likely try to cut interest rates and otherwise offer monetary stimulus to achieve "maximum employment," as Congress directs it to.It helps that this state of the world probably coincides with downward pressure on inflation, thanks to robust productivity growth implied by an AI-pocalypse.State of play: If some of the more aggressive forecasts of technologists come true, and AI supplants millions of human workers in the coming years, it would imply a period of rapid GDP growth, but elevated unemployment and diminished job prospects.At first glance, that might create a quandary for monetary policy makers. Central banks don't usually pull out their monetary stimulus guns when growth is robust. But not if you look at the words of the Federal Reserve Act and officials themselves.What they're saying: Chair Jerome Powell said in July that "our two mandate variables" are "stable prices and maximum employment, not so much growth.""Our mandates are very clear: price stability, full employment. And growth isn't in there," San Francisco Fed president Mary Daly told Axios this week."I think that's really helpful right now, because if people say, 'Well, look how fast growth is, but nobody has a job' ... I think that's where the dual mandate is really helpful, because it doesn't say growth; it says labor market," she said.Yes, but: As experienced in both the early 2000s and early 2010s, the ability of rates policy to encourage job creation is limited.The Fed can't really bail out the job market by fiddling with the knobs that control the price of money — but it can use control over the money supply to speed up labor reallocation after a big shock.Flashback: This was precisely the situation the Fed faced in 2002 and 2003. A mild 2001 recession had passed, and GDP started rebounding — but jobs didn't come with it.Rather, companies were able to achieve strong gains in output while adding few jobs — a jobless recovery. It reflected, in part, higher productivity as the IT investments of the late 1990s and the impact of globalization paid off.The unemployment rate peaked in June 2003 at 6.3% — two years after the recession. GDP was booming at the time, up 4.3% that year.The Fed cut its interest rate target that month to what then seemed like an ultra-low 1% and left it there for another year.The bottom line: "Were there to be a jobless recovery in the presence of a positive productivity shock and declining inflation, it is quite possible that an optimizing central bank should respond by lowering interest rates, not raising them," said Fed governor Ned Gramlich at the August 2003 closed-door policy meeting.And that's exactly what the Fed did.

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