Productivity Won't Save Us From Inflation, Fed's Schmid Warns

The promise that AI-driven productivity gains would cool inflation is hitting reality. Kansas City Federal Reserve President Jeffrey Schmid just delivered a sobering reality check to those banking on technology to solve our price problem.

The Productivity Paradox

Schmid's message was blunt: "It's too soon to expect productivity to fix still-elevated inflation." His reasoning cuts through the tech optimism—when productivity rises, wages typically follow, potentially offsetting any disinflationary benefits.

The numbers back him up. U.S. productivity surged 2.8% year-over-year in Q4 2024, yet core PCE inflation remains stubbornly at 2.8%—well above the Fed's 2% target. Both productivity and prices climbed together, defying the conventional wisdom.

Winners and Losers

Tech giants like Microsoft, Google, and Amazon are reaping productivity rewards from AI investments. Their workers are seeing fatter paychecks as companies compete for AI talent. But here's the rub: those wage gains ripple through the broader economy, pushing up costs everywhere else.

Meanwhile, consumers outside the tech bubble face a cruel irony. They're paying higher prices for goods and services while their own wages lag behind the productivity boom. The efficiency gains aren't translating to lower grocery bills or cheaper rent.

The Fed's Tightrope Walk

Schmid's comments highlight the Fed's impossible position. Raise rates further to combat inflation, and risk triggering a recession. Hold steady, and watch prices continue climbing. Even the supposed silver bullet of productivity gains isn't delivering the expected relief.

With the federal funds rate at 5.25-5.50%, markets are pricing in potential further hikes. The Trump administration's tariff policies could add fuel to the inflationary fire, making the Fed's job even harder.

The Global Context

This productivity-inflation disconnect isn't unique to America. European and Asian economies are grappling with similar dynamics as automation and AI reshape labor markets. The question isn't whether technology will eventually bring down costs—it's how long consumers can weather the transition period.