The narrative gaining traction in some circles – that artificial intelligence will deliver a productivity boom sufficient to compel the Federal Reserve to lower interest rates – is, at this point, premature. While AI holds long-term potential, current economic data suggest that recent productivity gains stem from factors predating widespread AI adoption, and a persuasive case for near-term rate cuts based on AI-driven productivity remains unconvincing.
Total factor productivity (TFP), a key measure of how efficiently an economy combines labor and capital to generate output, currently stands at 3.5%. This figure is notably below the levels experienced during the late 1990s and early 2000s, a period coinciding with the commercialization of the internet. Whether AI will ultimately spur a significant increase in TFP remains to be seen.
Recent increases in productivity are largely attributable to investment decisions made during and immediately following the pandemic. As the search results indicate, many businesses, facing a shifting labor landscape with some younger workers opting out of the workforce, rationally chose to increase investment in productivity-enhancing equipment, intellectual property, and software. These investments are now beginning to yield results, contributing to the observed economic resilience.
The U.S. Economy has demonstrated surprising resilience, with productivity growing roughly 2% year-over-year as of the third quarter of 2025, exceeding the rates seen in other developed markets. However, this growth has not translated into commensurate gains for workers. Data from the U.S. Bureau of Labor Statistics (BLS) reveal that the labor share of income – the portion of economic output accruing to workers – fell to a record low in the third quarter of 2025, a trend stretching back nearly eight decades.
This divergence – robust productivity growth alongside declining labor share – highlights a K-shaped economic recovery, where certain segments of the economy, particularly large, capital-intensive firms aggressively deploying technology, are pulling ahead, while a growing number of workers are falling behind. This dynamic is expected to persist, with significant ramifications for the economy, markets, and the political landscape.
Nonfarm labor productivity experienced substantial jumps in the second and third quarters of 2025, rising 4.1% and 4.9% respectively – the strongest two-quarter stretch in recent years. Crucially, unit labor costs also fell during this period, a rare and powerful signal that the economy is expanding its capacity without overheating. This mirrors the conditions observed in the late 1990s, although initial data underestimated the true extent of the productivity gains at that time.
The current surge in capital investment is largely driven by an “AI-infrastructure boom,” with data-center construction reaching record highs in 2025, exceeding $50 billion in U.S. Spending. This investment cycle, reminiscent of the fiber-optic and server room build-out during the dot-com era, is focused on AI data centers and semiconductor fabrication facilities. However, it’s important to note that this investment is still in its early stages, and the full benefits of AI deployment are yet to be realized.
While AI is poised to become a significant driver of productivity, its impact is currently limited. The technology is still in the early phases of implementation, as businesses grapple with how to effectively integrate it into their operations. Any substantial productivity boom attributable to AI remains “just over the horizon.”
Should productivity increase at a rate commensurate with overall economic growth, tax revenues could see a significant upside. However, this positive outcome is contingent on the absence of substantial employment disruptions caused by increased total factor productivity. The potential for job displacement remains a key concern as AI becomes more prevalent.
The implications for monetary policy are clear: calls for immediate interest rate cuts based on the promise of AI-driven productivity are, at this juncture, unwarranted. A cautious approach is advisable, as the full impact of AI on productivity and the labor market remains uncertain. Policymakers should heed the lessons of the past and avoid premature adjustments to interest rates based on speculative gains.
The current economic landscape is characterized by a complex interplay of factors, including pandemic-era investments, shifting labor dynamics, and the nascent stages of AI adoption. While the potential for a productivity boom exists, It’s crucial to distinguish between current realities and future possibilities. A measured and data-driven approach is essential for navigating this evolving economic environment.
