By Paul Vieira
OTTAWA--Bank of Canada policymakers might have to tolerate elevated inflation to help the economy adjust to the wider adoption of artificial intelligence, according to new central bank research.
The analysis, released Tuesday, examines the impact AI might have on the labor market and productivity, and lays out the challenges ahead for the Bank of Canada. The expectation is that AI lifts potential output, or the economy's speed limit, through productivity gains, while possibly lowering the natural rate of unemployment -- or the level at which the labor market fuels neither wage nor price gains.
The authors write AI adoption could create a two-speed economy. Sectors with high potential for automation may struggle and shed workers, while other sectors that offer complementary services alongside AI thrive and face price pressures like higher wages.
The economic adjustment, the authors say, will occur through relative-price increases in the expanding sectors. That leads to a scenario where inflation accelerates while the unemployment rate remains elevated. In theory, higher unemployment should limit firms' ability to raise prices.
"Inflation emerges not from excess demand, but from the need for relative-price realignment," the authors write in the paper about the paradox posed by AI. "In this circumstance, monetary policy should be cautious about responding to inflation driven by structural shifts. Attempts to suppress inflation through contractionary policy may slow or distort the reallocation process prolonging unemployment and output losses."
The findings align with one of the core messages from Bank of Canada Gov. Tiff Macklem -- that interest rates aren't the appropriate policy lever to help Canada cope with its current state of economic weakness. Macklem has argued rate cuts won't help an economy dealing with the dramatic shift in U.S. trade policy toward protectionism, the adoption of AI, and an aging population.
The economy grew 1.7% in 2025, although gross domestic product recorded declines in the second and fourth quarters. Canada's manufacturers have struggled under the pressure of hefty U.S. tariffs on Canadian-made goods such as steel, aluminum, motor vehicles and forest products.
"During the AI transition," write the research paper's authors, "monetary policy should exhibit measured flexibility. It may have to tolerate temporarily higher inflation to facilitate the necessary relative-price adjustments. This does not entail abandoning price stability as an anchor, but rather recognizing that some inflationary pressure is an unavoidable symptom of structural transformation."
Write to Paul Vieira at paul.vieira@wsj.com
(END) Dow Jones Newswires
03-03-26 1829ET
