Viewpoints

Starting on August 27, 2026, and running through August 29, 2026, the Federal Reserve Bank of Kansas City will host its annual “barbecue” in Jackson Hole, Wyoming. The best and the brightest of monetary policy gurus from around the world will be there and the highlight of every conference is the comments by the chairman of the Federal Reserve Board. (For some reason, my invitation has repeatedly been lost in the mail.) The theme of the 2026 conference is “Financial Innovation: Implications for Payments Policy”. Although this is an important topic, is it really the most pressing issue for the Federal Reserve to be considering? Of course, I am biased, but I believe that Fed should be discussing a superior way to conduct its monetary policy so as to more consistently achieve an inflation target, especially in an environment of random shocks to the aggregate supply of real goods and services. For whatever reason, these random shocks seem to have been occurring more frequently in recent years. So, I humbly suggest that Fed Chairman include in his remarks that the Federal Reserve operate in a manner such that the sum of depository institution reserves and the securities and loans on the books of depository institutions grow at some constant rate. (Depository institutions are commercial banks, saving institutions and credit unions. Commercial banks dominate depository institutions.) In what follows, I will provide empirical evidence demonstrating that growth in the nominal annual averages of this sum, let us call it “thin-air” credit, has a relatively high correlation with future growth in the nominal annual averages of domestic aggregate demand and the future rate of inflation associated with domestic aggregate demand. In addition to having relatively high correlations with growth in nominal domestic aggregate demand and the associated inflation rate, a constant rate of growth in “thin-air” credit will prevent cumulative increases or decreases in the rate of inflation. I will provide the rationale for why I believe 5-1/2 percent would be a reasonable target rate of growth in thin-air credit. I also will explain how the Federal Reserve can achieve, with precision, whatever target rate of thin-air credit growth it chooses without operating via a federal funds rate target. Not only would this modest proposal eliminate persistent overshoots and undershoots of the Fed’s inflation target, it would simplify the Fed’s communication challenges. In terms of forward guidance, all the Fed chairman would need to say at the end of every Federal Open Market Committee (FOMC) meeting is that the committee intends to have the sum of depository institution reserves plus securities and loans grow at a steady annual rate of 5-1/2 percent.

Plotted in Chart 1 are the year-over-year percent changes in the annual averages of the sum of depository institution reserves at the Federal Reserve, securities and loans (the blue bars) and the year-over-year percent changes in the annual averages of nominal Gross Domestic Purchases (the red line). (Monetary policy primarily influences domestic aggregate demand. That is why I have chosen nominal Gross Domestic Purchases as the “dependent” variable rather than Gross Domestic Product, because the latter involves exports, which is more of a function of foreign demand for US goods and services.) The gray shaded areas represent periods of recession. The highest correlation between these two series starting with 1955 data occurs when thin-air credit is advanced by one year. That correlation is 0.52 (shown in the upper left corner of the chart). This implies that growth in thin-air credit leads growth in nominal Gross Domestic Purchases by one year. So, what happens to thin-air credit this year has its largest effect on nominal Gross Domestic Purchases next year.

State labor markets were fairly stable in July. One state (Maryland) reported a statistically significant increase in jobs, and one state (New Jersey) clocked a significant decline. A full 10 states saw statistically significant drops in their unemployment rate, though none was larger than .2 percentage points. The highest unemployment rates were in DC (5.9%), Connecticut (5.2%), Oregon (5.2%), California (5.1%), Nevada (5.0%), and Washington (5.0%). Nebraska, New Hampshire, Hawaii, Vermont, North Dakota, and South Dakota had unemployment rates under 3.0%, while South Dakota’s 2.0% was the lowest in the nation.

Puerto Rico’s unemployment rate moved up to 6.0% and the island’s job count moved up by 2000.

The world is being pushed to invest more than it has in decades.

A world on autopilot Every few months the International Monetary Fund publishes a projection of the world economy, and the Blue Chip panel of forecasters, along with other bodies, does something similar each month; together they help to set the consensus against which everything else is judged. It describes a world returning gradually to normal: global growth a little above 3%, inflation drifting back to target, and US policy rates continuing to ease from their peaks. Its most consequential feature is one that is easy to miss, because it sits in an accounting identity rather than being stated as a view: investment in the advanced economies is projected to remain close to 22% of GDP for the rest of the decade, essentially flat, with national saving tracking it (chart below). The large external imbalances — the US deficit and the surpluses of China, Germany and the oil exporters — are expected to persist more or less unchanged, and the real interest rate that balances saving against investment drifts gently lower. It is, in short, a forecast of continuity, and this piece argues that continuity may well be the wrong assumption.

The world has become more fragmented politically in the past decade, which has heightened global risk and uncertainty. The diminished sense of security has caused many countries to increase military spending. While this may be a rational response for individual countries, collectively, the rise in military spending has been alarming and seems to be leading the world toward even more risk and uncertainty. This in turn may feed the need for more security. In addition, the devotion of so much of the world’s resources to military spending may be damaging for the global economy.

According to the Stockholm International Peace Research Institute (SIPRI), world annual military expenditure reached $2.8 trillion (in constant 2024 terms) in 2025. That figure represented a 41 percent increase in the past ten years. However, half of that rise occurred in the past three years. We looked at the SIPRI Military Expenditure dataset (available in Haver’s GLSECTOR database) to understand how and why military spending is changing across countries and regions.

Worldwide gains in military spending The rise in military spending has been widespread. Between the years 2022 and 2025, 45 of the top 50 countries in terms of military spending posted increases, with an average gain among that group of 41.8 percent. NATO spending (excluding the US) jumped by 44.7 percent, while non-NATO military spending increased by 29.2 percent.

Surprisingly, US military spending was essentially flat during this time. As a result, US military spending declined as a share of world spending by 6.6 percentage points to 33.5 percent. However, the Trump Administration has proposed a $1.5 trillion military budget for 2027, a roughly 60 percent increase from the 2025 spending listed in Figure 1. If that budget is enacted, then in 2027 the US's increase alone would be equivalent to 20 percent of 2025's entire world total. And we know that other countries both in NATO and Asia are ramping up spending as well.

It has been argued that AI could usher in "10x of the Industrial Revolution at 10x the speed." Yet, for AI to deliver on its growth potential for the economy, not just for a select group of companies, it needs to create jobs, lots of them- to generate worker income and spur consumption growth. So far, the records for growth, jobs, and productivity are unimpressive; however, to be fair, they are far from the final scorecard.

In the first half of 2026, even with double-digit annualized gains in business spending on technology equipment and intellectual property (AI), the economy saw an annual growth rate of 1.75%, with real consumer spending rising by 1.8%, the creation of 450,000 payroll jobs, and productivity growth of about 1%. Various factors impacted that growth and job performance, with AI emerging as the most significant influence.

AI is reportedly already managing or assisting with large volumes of white-collar tasks, allowing some companies to reduce their headcount. But the future impact could be more significant in scale and breadth. AI is designed to perform tasks traditionally done by humans, whereas the Industrial Revolution was a massive job creator.

Predicting the impact of AI on the total number of employed individuals is challenging. Nonetheless, if AI enables companies to downsize their workforce or eliminates the necessity to expand it, this could significantly harm overall economic performance.

This isn't a pessimistic view; it's simply basic arithmetic. Real consumer spending accounts for 70% of overall GDP growth (add another 3% for housing), while all types of business investment spending are less than 15%. If real consumer spending decreases by 100 basis points due to sluggish job growth, investments in AI models and infrastructure would need to increase by 3X or 4X above the current rate to maintain the same GDP growth rate.

Is it possible? A surge in AI investment of this magnitude would far exceed most companies' current cash flows, requiring unprecedented borrowing from the private sector. Yet, then the real question with AI is whether such an investment is essential, considering AI might impede the growth of its main market, the consumer, due to stagnant job growth.

It's crucial to find a balance where AI enhances GDP output and productivity without adversely affecting the job market to the point where consumer spending significantly decreases. However, it's uncertain where such a trade-off exists.

These issues will not be settled today, next month, or even next year. Historically, infrastructure booms and new technologies take years before their economic and financial benefits become evident. Nonetheless, all past innovations have ultimately created more jobs than they eliminated. For AI to be truly successful, it must create more jobs than it removes, and the responsibility to prove this lies with AI.

There continues to be talk about how high-income households are carrying the economy. Is this new? The Bureau of Labor Statistics (BLS) annually surveys households regarding their expenditures in the aptly-named Consumer Expenditure Survey (CES). The latest BLS Consumer Expenditure Survey is for 2024. So, we do not know what went on in 2025 and so far in 2026. But what we do know from the 2024 CES is that higher-income households continue to spend more than lower income households – duh. But what we also know is that in 2024, things were close to or at their 1984-2024 medians with respect to average annual nominal expenditures compared to aggregate expenditures. To wit, in 2024, average annual nominal expenditures for the bottom 20% income quintile for households compared to the total average expenditures of all income quintiles was 8.9% versus a median of 8.8%. The comparable figure for the top 20% income quintile for households was 38.3% versus its 38.3% median. These data as shown in the chart below.

The Bureau of Labor Statistics (BLS) reported on August 7, 2026 that the three-month moving average of the change in total nonfarm payrolls was only 20,000 in the three months ended July 2026. This compares unfavorably with the 142,000 average change in the three months ended May 2026. (See Chart 1). If we can believe the BLS data released on August 7, three months of which were revised, the US labor market has weakened significantly in the past three months.

The debate rages on: do lofty corporate equity prices indicate an enormous speculative bubble or an emerging, tech-driven golden age? High equity valuations are naturally a basic part of the discussion, but price-to-earnings ratios (P/E ratios) alone do not fully reflect the grandeur of the expectations built into today’s stock prices. What makes market expectations remarkable is that high earnings multiples are based on profits that have already recorded extraordinary growth to the point of historically wide margins. Large multiples and remarkably wide margins together explain corporate equity values that are unprecedentedly huge in proportion to corporate operations. The United States will have to undergo a dramatic economic acceleration and an enduring, unusually rapid expansion to avoid a major disappointment for the stock market. By all appearances, stock prices will need the emergence of an AI-driven golden age if their present level is to be justified.

A number of market observers have noted that the Buffett Indicator, which is the total value of U.S. corporate equity relative to GDP, is at an exceptional record high (chart 1). For half of a century after World War II, corporate equity was at most equal to GDP and sometimes less than half of it; presently, that corporate equity is worth two-and-a-half times GDP.