Contrary to its long-term deflationary promise, AI is currently fueling inflation. The massive build-out of data centers, demand for computer components, and wealth effects from tech stocks are creating a demand shock that outstrips the technology's nascent productivity gains, pushing prices higher.

The AI build-out increases real interest rates by demanding vast amounts of capital, crowding out other investments. Simultaneously, it pushes up nominal rates by creating inflationary pressure on physical resources like labor, energy, and materials needed for data centers.

A significant portion of current economic growth and employment is driven by capital-intensive AI build-outs, which also contribute to inflationary pressures. This presents a challenge for policymakers: raise rates to slow inflation at the risk of stifling a major technological revolution, or tolerate higher inflation to support it?

Contrary to the belief that AI is purely deflationary, its initial impact is inflationary. The massive, immediate demand for investment in data centers, chips, and energy far outweighs any short-term productivity benefits. This capital-intensive build-out puts upward pressure on interest rates and prices across the economy.

For central bankers, AI presents a paradox. While it's disinflationary in the long run via productivity, it's inflationary now. The massive investment in infrastructure and the wealth effects from AI stocks are juicing demand today, while the supply-side benefits will only materialize later, creating a near-term policy challenge.

Rising interest rates create a double-whammy for AI firms. They increase borrowing costs for massive infrastructure projects and simultaneously reduce stock valuations as analysts apply higher discount rates to far-future cash flows.

In the short-term, AI's economic impact is inflationary. The surge in demand from data center investments and stock market wealth effects is outpacing the supply-side gains from productivity. This imbalance argues for higher, not lower, interest rates to manage current inflation.

Traditional monetary policy tools like interest rate hikes are poorly suited to combat modern inflation drivers. They fail to address price pressures from specific industrial booms (e.g., AI memory chips) or the inflationary effects of large, persistent government deficit spending.

Massive capital expenditure in AI is driving a broad, inflationary expansion across all assets. This pressure is a key reason interest rates must rise significantly to find balance, potentially requiring a 30-year yield in the 6% range and a Fed Funds rate over 5.5%.