The IMF noted in its world economic outlook the current AI boom presents some parallels with the dot-com boom of the late 1990s. Market optimism about a new technology'the internet then, AI now'is pushing up stock valuations, fueling a tech-centered investment boom, and sustaining consumption on the back of strong capital gains. This could push the neutral interest rate up. Should the AI boom continue unabated, the risk is that demand pressures accentuate further, requiring tighter policies. Indeed, between June 1999 and May 2000, the Federal Reserve needed to raise its policy rate by a cumulative 175 basis points to contain inflationary pressures. But the risk is also that lofty profit expectations will ultimately be unmet'as often happens when new general-purpose technologies are introduced. A significant market repricing could impact aggregate wealth and consumption and spill over to broader financial markets, IMF noted.

Excessively optimistic growth expectations about AI could be revised in light of incoming data from early adopters and could trigger a market correction, it said. Elevated valuations in tech and AI-linked sectors have been fueled by expectations of transformative productivity gains. If these gains fail to materialize, the resulting earnings disappointment could lead to a reassessment of the sustainability of AI-driven valuations and a drop in tech stock prices, with systemic implications. A potential bust of the AI boom could rival the dot-com crash of 2000'01 in severity, especially considering the dominance of a few tech firms in market indices and involvement of less-regulated private credit loans funding much of the industry's expansion. Such a correction could erode household wealth and dampen consumption. To the extent that the AI hype has led to excessive capital flows into a narrow set of firms and sectors, any unwinding of these positions could then entail a slow economic recovery hampered by capital misallocation. These vulnerabilities are compounded by constrained fiscal space, which may limit the effectiveness of policy responses, IMF noted.

Powered by Commodity Insights