AI Boom Lifts GDP While Workers’ Wages Lag

The U.S. economy grew at a 3.4% annualized rate in the third quarter, but AI investment and spending by wealthier households drove much of the gain, while typical workers’ wages lagged behind rising prices. Economists now say accelerating inflation has strengthened the case for a Federal Reserve interest rate increase in December. Monetary authorities would make that decision, but borrowing costs and weaker demand would reach households already drawing down their savings.

Growth for whom?

Consumer spending rose at a 3.8% rate from July through September, matching the second quarter’s pace. Services led the increase, including health care, restaurant and bar visits, and hotel and motel stays, while spending on goods such as motor vehicles and household furniture pulled back. Higher-income households, whose wealth has risen with AI-related stock-market strength, drove much of the spending.

“Growth isn't enough to give American families economic security,” said Kyle Moore, chief economist at the Century Foundation. “Most of that growth has been lopsided, focused on the AI buildout. Wages for the typical worker still aren't keeping up with increasing prices.”

Historically low layoffs and moderate hiring helped sustain demand as households kept spending. But wage gains have at times lagged inflation, and people saved less and drew on their nest eggs. The saving rate fell to 4.1% from 4.4% in the second quarter, then dropped to 3.8% in September. The headline expansion comes with a bill: households have less income set aside as a cushion while prices continue to rise.

Business spending on equipment surged at a 20.9% rate, its fastest pace since the third quarter of 2020, adding 1.16 percentage points to GDP growth. Information-processing equipment, mainly computers and peripheral equipment, accounted for most of that contribution. Spending on intellectual-property products rose at an 8.4% rate, mostly through software and research and development.

The rate-setting apparatus

The Commerce Department's Bureau of Economic Analysis reported the growth figures Thursday. The report arrived less than a week before Tuesday's midterm elections, which will determine control of Congress. That same week, the Federal Reserve left its benchmark overnight interest rate in the 3.75%-4.00% range and acknowledged that inflation “remains elevated.” Economists said strong growth and Thursday’s inflation data strengthened the case for a December rate hike.

Inflation measured by the Personal Consumption Expenditures price index rose 0.5% in September after increasing 0.3% in August. PCE inflation reached 3.6% in the 12 months through September, up from 3.4% in August. The Fed tracks that measure as part of its 2% inflation target. Voters will decide who controls Congress; the central bank will make the rate decision.

Joseph Brusuelas, chief economist at RSM, said the data showed “an economy at full employment in addition to a historic capital expenditures expansion.” He cited “robust spending ... stratospheric private non-residential investment and sizzling inflation data” as reasons the Fed could act to restore price stability.

Costs passed down

Rising mortgage rates tied to the conflict in the Middle East pushed residential investment back into contraction. Higher borrowing costs outweighed moderating house prices and weakened housing demand. Government spending rose at a 5.3% rate amid a sharp rebound in federal defense and nondefense outlays, while imports increased at a 19.7% rate. Imports subtracted 2.64 percentage points from GDP growth, offset by consumer and business spending and a 1.61 percentage-point contribution from inventory rebuilding.

The strong quarterly numbers sit alongside signs of strain. Inflation-adjusted household disposable income fell 0.3% in September, and inflation-adjusted consumer spending was unchanged after rising 0.5% in August. Average gasoline prices remained above $4 a gallon as the U.S.-Israeli war with Iran continued. Economists anticipated slower growth by year-end.

Economists also expected some moderation in AI-related spending as investors weighed the rising costs of long-term projects with uncertain payoffs. Technology firms borrowed large sums over the past year to finance that spending, creating a potential downside risk to equipment investment. “An economy increasingly supported by stock-market wealth and large technology projects also faces risks if share prices retreat or investment plans disappoint,” said Sung Won Sohn, a finance and economics professor at Loyola Marymount University. The growth report counts the expansion. It doesn't promise security to people whose wages are still chasing prices.