Eve is here. The Fed and central banks generally never think deeply about the possibility of asset bubbles because they look like an increase in wealth to investors and onlookers unless they occur. We cited a 2007 Sydney Morning Herald op-ed by former Reserve Bank of Australia governor Ian Macfarlane on this issue. German section:
The single biggest challenge begins with the realization that as the economy develops, the fiscal side will grow much faster than the reality. As a result, economic outcomes will depend more on what happens in the asset markets than on what happens on the real side of the economy, such as the goods and labor markets…If there is a significant financial shock, such as a large decline in stock or real estate prices, the impact on the economy will be greater than before.
Therefore, the central question is whether asset market booms and busts are more likely to occur in the future…
If asset price booms and busts are at least as frequent as they have been in the past 20 years, and their impact on the economy is likely to be greater, what can monetary policy do about it?…
So if low inflation is no insurance, what should central banks do if they suspect a potentially unsustainable asset price boom is forming, especially if the boom is debt-financed?…
Many have pointed out that it is difficult to identify a bubble in its early stages, and this is true. However, even if a bubble can be identified, it can still be very difficult for central banks to take action to counter it, for two reasons.
First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in a particular area, such as home prices, the economy as a whole is affected. If confidence in a fast-growing sector is particularly high, it may initially be less affected by rising interest rates, but other parts of the economy may be affected.
Second, there is a larger question regarding the mandate given to central banks. While it is now widely accepted that central banks have been entrusted with the task of preventing a resurgence of inflation, nowhere, to my knowledge, have central banks been entrusted with the task of preventing large increases in asset prices that many people would see as increases in community wealth. Therefore, if they take on this additional role, they will face the daunting task of convincing the public of its necessity.
Even if central banks were convinced that a destabilizing bubble was forming and that its bursting would be catastrophic, local communities did not necessarily know to expect it, and could not find out until the whole situation had unfolded. If central banks forced interest rate hikes, they would be accused of risking recession to avoid what they feared, but not communities. Would a central bank be appreciated if, in the most favorable case, it raised interest rates by a modest amount to prevent the bubble from expanding to dangerous levels, at a relatively small cost in terms of income and employment growth? Almost certainly not…perhaps this episode will be seen by the public as a monetary policy error because we will never be able to observe what happened.
So Wolf was right when he used the word “fret.” Too much lending currently takes place outside banks, so regulators are unable to introduce credit controls or signal that lending to certain sectors will be subject to special scrutiny.
Written by Wolf Richter, editor of Wolf Street. First appearance: Wolf Street
In the June 16-17 FOMC minutes released today, “AI” was mentioned 21 times, and in the previous FOMC meeting minutes in April, it was mentioned eight times, but the combinations are as follows.
“AI construction” (4 times), “AI infrastructure” (2 times), “AI-related investment” (3 times), “AI business investment”, “AI investment”, “AI-related capital investment”, “AI-related expenditure”, “AI introduction” (2 times) “Impact of AI on corporate profitability” “AI-related price pressure” “AI-related demand” “Optimism about AI”
plus:
Some participants commented that AI could impact the employment prospects of some workers over time.
Strong corporate earnings and continued optimism from AI-related investors contributed to the rise in foreign stock prices.
The AI investment mania is now officially a demand driver, driving up consumer prices for things like electricity, high-tech products, stock prices, and corporate input costs, and trying to pass them on. And that is now.
However, the expected productivity gains and the deflationary pressures brought on by AI were uncertain, and it was thought that the following would occur in the future.
Some participants said that productivity gains associated with AI implementation should ultimately reduce production costs, increase aggregate supply, and put downward pressure on inflation, but noted that this effect is likely to take time to materialize.
and:
Some participants suggested: [AI] Investments could increase productivity and potential output growth in the coming years. However, these participants noted that considerable uncertainty remains regarding both the timing and scale of potential productivity gains, which are expected to lag the continued acceleration of on-demand AI adoption.
In contrast, two other Fed policies, “energy” and “tariffs” as a result of the Iran war, were only mentioned 13 and 7 times, respectively, in today’s minutes.
You mentioned “power” once, in the context that AI will drive up power prices along with the price of high-tech products, thereby pushing up inflation:
Many participants noted that demand for AI infrastructure remains strong, and upward pressure on prices for technology products and electricity is likely to continue.
Other mentions include:
Many participants noted that demand for AI infrastructure remains strong, and upward pressure on prices for technology products and electricity is likely to continue.
However, most participants also pointed to scenarios in which inflation remains high due to strong AI-related demand, the Middle East conflict, or the impact of tariffs, while labor market conditions remain stable.
Most participants emphasized that growth in economic activity above potential output, in part due to strong investment in AI businesses, could contribute to more sustained inflationary pressures.
Some participants noted that broader financial conditions were supporting demand. These participants specifically pointed to the stock’s high price, which they attributed to strong corporate earnings and optimism about AI.
Participants generally expected strong real GDP growth to continue throughout the year and pointed to several factors likely to support continued expansion, including continued AI-related investment, household spending, and fiscal policy.
The AI investment mania, the hundreds of billions of dollars that investors are eagerly spewing out and being thrown out left and right, and the demand and inflationary pressures those hundreds of billions generate, is beginning to seep through the economy. And the Fed is starting to worry about the impact.
While these pressures from the AI investment mania could fuel a second wave of inflation, it is refreshing to see the Fed taking this threat to price stability seriously, rather than “seeing through” these pressures and waiting for them to somehow dissipate on their own.
So at the June FOMC meeting, the Fed reversed course, according to today’s meeting minutes. The discussion was about whether to raise rates, with a “few” participants even admitting there was “a case” for raising rates at the June meeting.
In contrast, meetings last year and earlier this year discussed whether to cut rates, and the Fed cut rates three times last fall.
It is rare for the Fed to raise rates once. In most cases, a rate hike means a new rate hike cycle to control inflation.
Core and overall inflation measures have exceeded the Fed’s targets for more than five years. The Fed’s preferred core PCE price index, which excludes energy and food, accelerated its rise from mid-2025, reaching 3.4% in May. The PCE price index was released two weeks after the Fed meeting, but participants only had estimates of it, not actual data.
The six-month core PCE price index, which represents the current trend, accelerated to an annualized rate of 4.1%, its worst level in three years. This does not include the rapidly increasing energy component. The big drivers were non-housing core services, power and high-tech products.
The six-month Core Services PCE Price Index, which is a major driver of the Core PCE Price Index, accelerated its rise from mid-2025 and reached 4.2% in May. Core services account for the majority of consumer spending. And this time, it is services other than housing that are causing an uproar. The situation would be even worse if electricity were included as a core service.
The all-commodity PCE price index, which is the basis of the Fed’s 2% target, has exceeded the Fed’s 2% target for more than five years since March 2020, and now the Fed’s de facto target has been implicitly moved to the 3% to 4% range, leading to widespread speculation, including here, that 2% is nothing more than lip service.
If the Fed wants to break that assumption, it’s going to have to get busy. If the Fed were to sit back and scrutinize this inflation, it would be evidence that the Fed has indeed moved its defactor target into the 3-4% range, and if Mr. Warsh came out and said that, it could send long-term Treasury yields and mortgage rates still clinging to the 2% illusion flying off the handle.
In case you missed it: Consumers are already noticing fluctuations in “inflation expectations,” throwing another curveball at the Fed.
