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Russia’s war and the global economy

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A woman leaves a currency exchange office displaying the US dollar and the euro signs in Saint Petersburg on Wednesday. Russian authorities are scrambling to stem panic as massive sanctions over Moscow’s military offensive in Ukraine delivered the worst economic shocks since the fall of the Soviet Union. AFP

Russia’s war and the global economy

Now that Russian President Vladimir Putin has launched a full-scale military offensive in Ukraine, we must consider the economic and financial consequences of this massive historic development.

The Ukraine war is not just another minor, globally inconsequential conflict. This is a major escalation of Cold War II, in which four revisionist powers – China, Russia, Iran, and North Korea – are increasingly challenging the long global dominance of the US and the Western-led international order that it created after World War II.

The risk now is that markets and political analysts will underestimate the implications of this global regime shift. Yet in terms of the broader economy, a global stagflationary recession – a period of inflation combined with a decline in gross domestic product (GDP) – is now highly likely. The war in Ukraine will trigger a massive negative supply shock to the global economy, reducing growth and further increasing inflation at a time when inflation expectations are already becoming unanchored.

A short-term financial market impact of the war is already foreseeable, as are spikes in oil and natural gas prices – to well above $100 per barrel. Anticipate a rise in the price of other commodities as well since both Russia and Ukraine are major exporters of raw materials and food. Safe haven currencies such as the Swiss franc will strengthen, and gold prices will rise further.

The economic and financial fallout from the war, and the resulting stagflationary shock, will of course be largest in Russia and Ukraine, followed by the EU, owing to its heavy dependence on Russian gas. But the US will suffer, too. Because world energy markets are so deeply integrated, a spike in global oil prices will strongly affect US crude oil.

Yes, the US is now a minor net energy exporter; however, the macro-distribution of the shock will be negative. While a small cohort of energy firms will reap higher profits, households and businesses will experience a massive price shock, leading them to reduce spending. Tighter financial conditions and the resulting effects on business, consumer, and investor confidence will exacerbate the negative macro consequences of Russia’s military offensive, both in the US and globally.

Likewise, the coming sanctions against Russia – however large or limited they turn out to be, and however necessary they are for future deterrence – inevitably will hurt not only Russia but also the US, the West, and emerging markets. Moreover, one cannot rule out the possibility that Russia will respond to new Western sanctions with its own countermeasure: namely, sharply reducing oil production to drive up global oil prices even more.

Although central banks should confront the return of inflation aggressively, they most likely will try to fudge it, as they did in the 1970s. They will argue that the problem is temporary, and that monetary policy cannot affect or undo an exogenous negative supply shock. When the moment of truth comes, they will probably blink, opting for slower monetary tightening to avoid triggering an even more severe recession. This will further de-anchor inflation expectations.

Politicians, meanwhile, will try to dampen the negative supply shock. In the US, policymakers will try to mitigate the rise in gasoline prices by drawing down its strategic petroleum reserves, and by nudging Saudi Arabia to increase oil production. But these measures will have only a limited effect, because widespread fears of further price spikes will result in global energy hoarding.

Nor can Western leaders rely on fiscal policy to counter the growth-dampening effects of the stagflationary shock. For one thing, the US and many other advanced economies are running out of fiscal ammunition, having pulled out all the stops in response to the Covid-19 pandemic.

It is tempting to think that the Russia-Ukraine conflict will have only a minor and temporary economic and financial impact. After all, Russia represents merely three per cent of the global economy (and Ukraine much less). But the Arab states that imposed an oil embargo in 1973, and revolutionary Iran in 1979, represented an even smaller share of global GDP than Russia does today.

Putin’s war will strike a massive blow to global confidence at a time when fragile recovery was already entering a period of uncertainty and rising inflationary pressures. The knock-on effects from the Ukraine crisis will be anything but transitory.

Nouriel Roubini is professor emeritus of economics at New York University’s Stern School of Business.



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