I’ve been sitting on this for a while. At Project Syndicate Nouriel Roubini cautions us not to underestimate the economic impact of Russia’s war against Ukraine:
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. As US President Joe Biden has repeatedly made clear in his public statements to the American people, “defending freedom will have costs for us as well, here at home. We need to be honest about that.â€
Moreover, one cannot rule out the possibility that Russia will respond to new Western sanctions with its own countermeasure: namely, sharply reducing oil production in order to drive up global oil prices even more. Such a move would yield a net benefit for Russia so long as the additional increase in oil prices is larger than the loss of oil exports. Putin knows that he can inflict asymmetrical damage on Western economies and markets, because he has spent the better part of the last decade building up a war chest and creating a financial shield against additional economic sanctions.
A deep stagflationary shock is also a nightmare scenario for central banks, which will be damned if they react, and damned if they don’t. On one hand, if they care primarily about growth, they should delay interest-rate hikes or implement them more slowly. But in today’s environment – where inflation is rising and central banks are already behind the curve – slower policy tightening could accelerate the de-anchoring of inflation expectations, further exacerbating stagflation.1
On the other hand, if central banks bite the bullet and remain hawkish (or become more hawkish), the looming recession will become more severe. Inflation will be fought with higher nominal and real policy rates, increasing the price of money, and thereby dampening the overall economy. We have seen this movie twice before, with the oil-price shocks of 1973 and 1979. Today’s re-run will be almost as ugly.
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 a slower pace of monetary tightening to avoid triggering an even more severe recession. But this will de-anchor further inflation expectations.
I suspect that Dr. Roubini’s prediction of the reaction of central banks is likely correct—they’ll “fudge it” which will result in a need for more strenuous actions as well as a more severe recession down the road.
Some are predicting a global famine as an indirect consequence of the war. I certainly hope that won’t happen but, given the U. S.’s poor wheat harvest this year (the poorest in 50 years), prices for all sorts of things will undoubtedly rise. Those price hikes are likely really to begin to bit this fall.
I’ve already expressed my opinion: graduated but decisive action on the part of the Federal Reserve and prudent fiscal measures on the part of the Administration, directly addressing our vulnerabilities. Do I believe that will happen? What do you think?
