Viewpoints: October 2026

The US economy saw a significant 3.4% rise in Q3 real GDP. Despite this impressive figure, it falls far short of the expectations set by some "bullish pundits" regarding the AI boom's impact. A surge in business investment helped boost the Q3 economic performance, but it does not represent a sustainable economic boom in its current form. Business investment in equipment, mainly AI technology, rose 20% annualized in Q3. However, the primary factor driving the economy's growth beyond 3% was the 3.8% rise in real consumer spending, with a 4% increase in consumer spending on services. There is limited hard data on services at press time, so revisions are possible. Even if the increase in real PCE is accurate, its sustainability is questionable. Real disposable income advanced only 1.7% annualized in the quarter and 0.8% over the past year. Without stronger income growth, the Q3 consumer spending performance is unlikely to be repeated. Additionally, if AI experts are correct, the rapid investment in AI technology could eliminate thousands, if not millions, of existing jobs, making the outlook for consumer spending concerning at best. (Note: consumer spending accounts for 70% of GDP and business investment in equipment accounts for 7%).

The Federal Reserve, Bank of Canada, European Central Bank and Bank of Japan meet this week against a difficult backdrop. An energy shock has pushed inflation higher just as households and businesses are contending with expensive borrowing. Economic growth has proved resilient, but the question for policymakers is how secure that resilience really is. There is a strong case for caution before tightening monetary policy further.

The immediate dilemma is familiar. Central banks cannot prevent an oil price shock, but they must guard against its spreading into wages, other prices and inflation expectations. At the same time, higher energy bills reduce spending power and raise costs for businesses. Further increases in interest rates could compound that pressure, even as the effects of earlier tightening are still being felt.

For now, there is little evidence that higher energy prices are feeding into broader inflation. The foundations of demand also deserve closer scrutiny. Government borrowing, rising asset values and investment based on expectations of future returns have all supported spending. Those supports may be less durable than the headline growth figures suggest.

The danger is that policymakers mistake this spending for lasting economic strength. Until productivity gains translate into broader income growth, further tightening risks undermining both today’s demand and the revenues needed to justify tomorrow’s investment. That does not mean central banks should overlook persistent inflation. It does mean they should weigh the evidence for it against the fragility of the growth they are seeking to restrain.

The evidence on inflation Latest data for September show that core CPI inflation, which strips out food and energy, is 2.6 per cent in the United States, 2.5 per cent in the euro area and 2.4 per cent in Japan. None has moved materially higher over the past six months, and the American and Japanese measures are lower than a year ago. So far, the rise in headline US inflation to nearly 4 per cent has not been accompanied by a comparable increase in core inflation.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in September showed moderate growth. In the one-month changes, three states, located in three corners of the nation--had increases greater than .5 percent (South Carolina, Nevada, and New Hampshire). However, 10 saw declines. Over the three months ending in September Nevada’s index rose more than 2 percent, and South Carolina’s was up more than 1.5 percent. Alabama and Hawaii saw declines. Over the last twelve months Nevada’s index rose a marked 4.77 percent, South Carolina was also up more than 4 percent, and 9 other states saw increases of over 3 percent. Of the remaining states, 34 had increases of at least 1 percent, while Hawaii, Alabama, and Connecticut registered small declines.no state saw an increase of 4 percent or more—Nevada’s 3.76 percent was the highest (six other states had increases above 3 percent). Alabama and Connecticut were down, and six others saw increases of less than one percent. r percent (Idaho was up 3.62 percent), and six others were at or higher than three percent.

The independently estimated national estimates of growth over the last three and twelve (respectively, .45 and 1.91 percent) appear to be a bit lower than what the state numbers would have suggested.

The AI boom faces a problem beyond the technology itself: its prospective customers must be able to afford it. Investment in computing capacity is adding to demand for power, equipment and capital before comparable productivity gains have spread across the economy. If those pressures weaken customers’ spending power, they may also constrain the revenues needed to justify the build-out. AI can fulfil its technical promise while disappointing those who finance it.

This helps explain why weakness outside technology should concern technology investors. The immediate beneficiaries of infrastructure spending are easy to identify. The eventual returns depend on a much broader group of businesses earning enough from AI to pay for its services. Those two stages need not proceed at the same pace.

The costs arrive first Every investment boom creates demand before it creates productive capacity. For AI, the timing matters because several essential inputs are slow to expand. Power stations, grid connections and transformers take years to deliver. A well-funded buyer can secure priority without increasing what is immediately available to everyone else.

Electricity makes the constraint tangible. Data centres add demand to networks already serving competing needs. Fuel prices, weather and available generating capacity also matter, so rising power costs cannot simply be attributed to AI. Nevertheless, the build-out can intensify local shortages. For other users, the consequences include higher operating expenses and delays to investment, even if they have yet to adopt the technology.

State labor markets were little-changed in September. New Jersey and South Carolina recorded statistically significant increases in jobs, while Wisconsin saw a decline (though the Brewers sweeping the Dodgers is likely providing great solace). Five states saw significant drops in their unemployment rates (Florida, Maryland, Nevada, New Hampshire, and Pennsylvania), though none was larger than .2 percentage points. The highest unemployment rates were in DC (5.6%), Oregon (5.1%), California (5.1%), Oregon (5.0%), and Michigan (5.0%). However, Oregon’s rate was not regarded as statistically higher than the nation’s 4.2%.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 increased to 6.2%, reflecting another marked increase in the island’s labor force (July saw a .8% rise), while the island’s job count fell 1,500.

The Treasury released its monthly September 2026 and Fiscal Year (FY) budget data on October 16, 2026. As expected, it showed that interest on the debt exceeded national defense expenditures in FY 2026 and that as a percent of net Treasury receipts, interest on the debt reached 19.5%, the highest at least since 1940. Given the amount of marketable Treasury securities that have to be refinanced in the next three years, not to mention additions to the outstanding stock of Treasury securities due to persistent budget deficits, and given the current and expected level of interest rates, interest on the debt is on track to continue to grow absolutely and relatively. The Treasury is borrowing more and more just to pay the interest on its debt. With an upward-sloping Treasury yield curve (the yields on longer-maturity Treasury securities are higher than those on shorter-maturity issues), Treasury Secretary Bessent is shortening the maturity of outstanding Treasury securities by issuing new short-maturity debt and funding the buyback outstanding longer-maturity debt with short-maturity debt in an effort to mitigate the interest expense on the public debt. But if the Federal Reserve were to increase the federal funds rate in an effort to lower the inflation rate, this would frustrate Treasury Secretary Bessent’s plan. If the Federal Reserve were to reach an “accord” with the Treasury to keep the federal funds rate artificially low, the increase in interest on the public debt could be mitigated. This would be debt default by another name – higher inflation.

Let’s look at some data. Plotted in Chart 1 are the fiscal year observations of net interest payments on federal debt as percent of net receipts of the Treasury (the blue bars) and the monthly observations of the average interest rate on Treasury marketable interest-bearing debt through September 2026 (the red line). In FY 2026, net interest on the federal debt was 19.5%, the highest in decades. The last time interest as a percent of net budget receipts approached FY 2026’s level was in the mid 1980s through the late 1990s, when the average interest rate on marketable debt was considerably higher than it was in FY 2026. For example, the average interest rate on marketable Treasury debt in September 1991 was 8.058% as interest in relation to net receipts was 18.4%. As of September 2026, the average interest rate on outstanding marketable Treasury debt was only 3.518% while interest as a percent of net receipts was a full percentage point higher than it was in FY 1991. Obviously, the reason for this is that there is a much larger outstanding stock of federal interest-bearing debt.

Weak growth and divided governments complicate fiscal repair and the investment needed to improve productivity.

Europe is caught in a difficult circle. Weak growth is undermining confidence in governments, while political fragmentation makes it harder to agree on the reforms and budgets that might restore it. Higher debt-servicing costs leave less room to reconcile competing demands. Economic disappointment and political division risk reinforcing one another, limiting the ability to strengthen growth.

There is no painless way out. Spending cuts can depress activity and alienate voters, while further borrowing may add to the debt without improving the capacity to service it. Higher productivity offers a more promising escape: AI could raise incomes and tax revenues enough to ease the burden. But the investment needed to secure those gains competes for capital and energy, potentially raising Europe’s costs well before it raises European incomes.

That delay matters for monetary policy. Further ECB tightening might restrain inflation, yet also weaken investment and demand in economies struggling to grow. Europe must therefore improve its capacity to invest and govern while managing the immediate pressures on household incomes and public finances.

The difficulty of governing France illustrates the problem. Its minority government is struggling to secure support for a budget intended to curb the deficit. In Spain, a parliamentary defeat over measures to ease the housing crisis has prompted a snap election. In Germany, regional gains by the far-right AfD are putting the governing coalition under pressure. Different economic circumstances have produced a common difficulty: assembling durable support for difficult choices.

Those choices are becoming more expensive. Voters want better services and relief from living costs, while defence and energy security require greater spending. At the same time, governments must refinance debt issued when interest rates were much lower. Rising interest bills leave less room to satisfy these demands, making political agreement harder just as the cost of failing to reach it increases.

Weak growth weakens consent The roots of this difficulty extend well beyond the latest political disputes. The World Bank’s political-stability measure shows a broad deterioration across advanced economies over the past decade. Germany has suffered a particularly marked decline, whereas Greece and Italy have improved or held their ground after earlier periods of upheaval.

Korea is emerging from the extraordinary political turmoil of 2024–25, triggered by former President Yoon Suk Yeol’s declaration of martial law in December 2024 and subsequent impeachment. The Lee government has since consolidated its political position, winning 12 of 16 major mayoral and provincial contests in June.

Political upheaval was not the only challenge. Last year was difficult for Korean exporters too, and external headwinds remain. Korean goods continue to face 15% US import duties, with tariffs on certain products rising by a further 10–12.5% in July 2026 under measures related to forced-labour policies.

Yet Korea—and its exporters in particular—has bounced back. Riding the global semiconductor upcycle and successfully diversifying export markets, exporters have seen both volumes and pricing power rebound sharply. In August, export volumes rose at a double-digit rate for the ninth consecutive month, climbing 26% YoY, while export prices surged 40.7%.