Economist Fernández-Villaverde: AI Raises Real Interest Rates, Bystander Economies Face Fiscal Unsustainability Risks
In a new paper, economist Jesús Fernández-Villaverde models the macro-fiscal consequences of the AI transition: AI investment demand forces real interest rates to rise sharply. Economies adopting AI can stabilize debt by taxing capital income, while bystander economies, with low capital income shares and unchanged growth, face fiscal gaps that no tax system can resolve, leaving them forced to choose between default, inflation, or financial repression.
The AI transition requires massive investment, and the only way to induce savers to fund these investments is through a sharp rise in real interest rates. This is the core mechanism proposed by economist Jesús Fernández-Villaverde in his new paper, "Saving for the Machines." In his baseline scenario, the ten-year real yield jumps from 5.1% to 13.6%. For governments, this means borrowing costs skyrocket.
Fernández-Villaverde sets up a transparent but extreme comparison: an economy with government debt at 100% of GDP that maintains a primary budget balance thereafter sees its debt ratio change solely based on the difference between the real interest rate and the growth rate. He distinguishes two types of economies. The first are AI adopters (such as the United States), which experience an AI boom domestically, paying the new interest rates while also enjoying faster growth. The second are bystanders (such as Spain), which exist within integrated financial markets but do not adopt AI, paying the same global interest rate while growth remains stuck at the 1.6% trend level.
For adopters, the situation is severe but has a solution. Taking the intertemporal elasticity of substitution among tasks as unity, the real interest rate rises to 42% by 2040, while growth increases only from 1.6% to 22%. The gap between interest rates and growth does not narrow; instead, it widens. Debt doubles by 2038, reaches 296% of GDP in 2040, and 907% in 2045. However, adopters have a way out: AI drives the capital share toward one, meaning net capital income accounts for approximately 88% of GDP. A flat tax of 36% on this tax base can stabilize debt at 100% of GDP in the limit. Fernández-Villaverde notes that the tax rate is higher than the nominal gap because it simultaneously suppresses growth without lowering the rate paid by the Treasury—which is locked by the net return on machines. It is painful, but the boom survives, and adopters can service their debt.