Can an AI-Driven Productivity Boom Solve the U.S. Debt Problem?
The fiscal benefits of faster productivity growth may be smaller than they appear.
In my previous piece on U.S. government debt, I investigated the trajectory of the U.S. debt-to-GDP ratio and argued that the fiscal outlook ultimately depends on the relationship between the real interest rate on government debt, the rate of economic growth, and the size of the primary deficit. I concluded that faster economic growth may offer a way out of an otherwise difficult fiscal situation.
That observation raises a natural follow-up question. If recent advances in AI lead to a sustained increase in productivity, and if that translates into faster real GDP growth, could that by itself materially improve the U.S. fiscal outlook?
To a point, yes. If economic growth were to rise while everything else remained unchanged, then growth in the U.S. debt-to-GDP ratio would slow, potentially stabilizing the fiscal outlook without the need for spending cuts.
But while it is reasonable to think that faster growth need not directly affect the primary deficit, basic economic theory suggests that the real interest rate and the growth rate of the economy are not independent variables. If AI meaningfully raises productivity growth, it should also raise expected returns to investment, which in turn affects the equilibrium price of capital. Once that mechanism is taken into account, the extent to which faster growth improves debt dynamics is likely to be smaller than the most optimistic versions of the AI story imply.
The central question, then, is not whether recent advances in AI will increase economic growth. It is whether economic growth will accelerate by more than the real interest rate on government debt rises.
A Brief Recap of Debt Dynamics
In my last piece, I showed that debt sustainability does not depend on the rate of economic growth alone, but on the gap between the rate of economic growth and the real interest rate on government debt. This can be seen by examining the following equation which characterizes the change in the debt-to-GDP ratio, Δ(D/Y):1
where 𝑟 is the real interest rate on government debt, 𝑔 is the growth rate of real GDP, and PD/Y is the primary deficit-to-GDP ratio.
This equation implies that the debt-to-GDP ratio can be stabilized so long as the primary deficit is not too large and 𝑔 > 𝑟. The intuition behind this result is that when economic growth exceeds the real interest rate, the economy’s taxable capacity is rising faster than interest is accruing on government debt, making any given level of government debt easier to manage.
In particular, if real GDP growth runs at 3 percent and the real interest rate on government debt is 2 percent, stabilizing today’s debt-to-GDP ratio of around 100 percent would require cutting the primary deficit roughly in half from its current level of around 2 percent of GDP to just 1 percent of GDP.
By contrast, if growth were to accelerate to 4 percent, holding 𝑟 fixed, the debt-to-GDP ratio could be stabilized at around 100 percent without the need for any meaningful fiscal tightening. In this sense, faster growth appears to offer a way out of an otherwise difficult fiscal situation.
This is what makes the prospect of AI-driven growth so appealing to those concerned about the U.S. fiscal outlook. If AI can push the rate of real economic growth up by just a single percentage point, the U.S. debt trajectory becomes considerably more sustainable.
This conclusion assumes that the difference between 𝑔 and 𝑟 increases as economic growth accelerates. In other words, it is based on an increase in 𝑔, ceteris paribus. What happens if 𝑟 changes as well in response to an acceleration in the rate of economic growth?
An AI Productivity Boom Will Likely Raise Interest Rates
A useful way to think about the link between productivity growth and real interest rates is via the marginal product of capital.2 In a standard neoclassical model, the real interest rate is tied to the marginal product of capital (MPK) net of depreciation (δ):3
An increase in productivity raises the marginal product of capital, which in turn puts upward pressure on real interest rates throughout the economy.
The basic idea is that if capital markets are competitive, funds will flow to those projects which offer investors the highest risk-adjusted return on investment. An increase in productivity in one part of the economy will tend to attract investment flows, which puts upward pressure on required returns elsewhere as firms compete for capital. Thus, if AI raises productivity growth in a way that increases the marginal product of capital, it will likely put upward pressure on real interest rates throughout the economy, including on U.S. government debt.
This does not mean that the real yield on Treasury debt will move one-for-one with the return on private capital. Government debt is a safe and liquid asset, and its yield reflects more than just the marginal product of capital. Still, it would be surprising if the government’s cost of borrowing were completely insulated from a broad-based increase in real returns elsewhere throughout the economy.
We may already be seeing some version of this mechanism in the rush to build data centers, chip capacity, and power infrastructure tied to the AI buildout.
What This Implies about Debt Sustainability
An AI-driven productivity boom is likely to improve the fiscal outlook by accelerating long-run economic growth. A larger and faster-growing economy can support a larger stock of debt, and that was one of the main points of my earlier piece.
The key question, however, is not whether an AI productivity boom will increase the rate of economic growth. It is whether it raises growth by more than it raises the real interest rate on government debt.
The answer will depend on how large the productivity gains turn out to be, how investment‑intensive the AI transition is, how much of the increase in private returns feeds through into the real yield on Treasuries, and how monetary and fiscal policy respond along the way.
What economic theory suggests, at a minimum, is that it is too simplistic to treat faster productivity growth as a silver bullet for the debt problem. An AI productivity boom may well help slow the rise in the U.S. debt‑to‑GDP ratio, but the equilibrium response of real interest rates will likely limit how much it can do on its own.
That does not make the optimistic AI story wrong; it just makes it more nuanced than some recent commentary suggests.
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About the Author: Seth Neumuller is an Associate Professor of Economics at Wellesley College where he teaches and conducts research in macroeconomics and finance. He holds a Ph.D. in economics from UCLA. His Substack is Mildly Efficient (and Occasionally Rational) where he explores topics in finance and macro from first principles, cutting through complexity with clear, grounded analysis.
Notes and Sources
AI tools were used to edit prose.
See my last piece for how to derive this equation from first principles.
The marginal product of capital is the additional output that a firm could produce if it were to increase its capital stock by one unit.
Here I assume that firms’ real cost of capital equals the real interest rate on U.S. government debt. In practice, since U.S. government debt is both highly liquid and risk-free, we would expect to observe a positive gap between these two variables. As long as this gap is not impacted by changes in the rate of productivity growth, all of the analysis in this piece goes through just fine.