Citi sounds the alarm for a deflationary spiral if AI sparks high unemployment and only benefits a small elite

• Citi said it believes the US could eventually see deflation as AI job losses pile up.
• The bank said it was possible that the benefits of AI productivity gains are captured by a "small AI elite."
• Uneven incomes could cause prices to fall as some pull back on spending, it suggested.

Citi sees the potential for a new AI-related crisis brewing in the economy: deflation.

In a note to clients on Friday, researchers at the bank said they believe that more companies adopting AI will eventually lead to higher unemployment. Those job losses could later lead the US down a deflationary path, a precarious situation in which inflation doesn't just slow, but prices actually fall. While that sounds like a boon for consumers, the reasons behind deflation aren't good.

Economists often view deflation as a more difficult problem to solve than too-hot inflation. The Fed can raise interest rates to bring down higher prices, but in the case of deflation, central bankers can only lower interest rates so much before they need to turn to other options to boost the economy.

The US has experienced deflation only a handful of times over the last century, and each time was during unprecedented economic stress, such as the Great Depression and the Great Financial Crisis.

"Eventually AI implementation will lead to higher unemployment and deflation, and the skew for US rates is likely lower," the bank wrote, though it noted that the timing of AI-related developments remains "very unclear."

Worries about widespread job losses stemming from AI are on the rise this week, following a viral report from Citrini Research outlining one scenario in which unemployment could soar to over 10% by 2028. Fears about AI's impact on the labor market gained more traction on Friday, after Block slashed nearly half of its workforce.

Some market pros have argued that the productivity benefits from AI could offset any potential damage stemming from job losses. Yet, Citi says there's a risk that productivity gains from the technology mostly benefit a "small AI elite," which could cause income distribution to be "very skewed."

In that scenario, prices in the economy would likely fall as unemployment rises, causing more people to tighten their spending, they said.

"A technological disruption combined with heavily concentrated winners means strong growth can coexist with unemployment and deflation," the bank wrote. "So, a high unemployment, deflationary scenario is certainly possible."

The job market overall looks to be on shakier footing recently. While the unemployment rate has held steady at around 4%, hiring has largely stalled over the past year, while layoffs have edged higher.

Consumer inflation cooled more than expected to a 2.4% annual rate in January, while wholesale inflation came in hotter than anticipated at 2.9%.