The Economic Consequences of Vladimir Putin’s War

CAMBRIDGE, Mass. – Russia’s invasion of Ukraine was swift and dramatic, but the economic consequences will be much slower to materialize and less dramatic.

The war itself is extremely tragic, first and foremost for the Ukrainian people, but also for the Russian people and the world order in general. When something like this happens, we expect it to be like a morality play in which all the bad consequences happen equally dramatically across all dimensions, including the economy. But the economy doesn’t work that way.

Admittedly, the financial markets reacted quickly to the announcement of the Russian invasion. The MSCI All Country World Index, a leading indicator of global equities, fell to its lowest level in nearly a year. The price of oil rose above $100 a barrel, while natural gas prices in Europe initially jumped nearly 70%.

These increases in energy prices will have a negative effect on the global economy. Europe is particularly vulnerable, as it has done little in recent years to reduce its dependence on Russian gas, and in some cases, notably Germany, which has abandoned nuclear, it has even exacerbated it.

Oil-importing countries will be penalized by rising prices. The United States is more hedged: because its oil production equals its oil consumption, more expensive oil is roughly neutral for gross domestic product. But rising oil prices will hurt American consumers while helping a more limited segment of businesses and workers tied to the oil and gas industry. Soaring prices will also add to inflation, which is already at its highest level in a generation in the United States, Europe and other advanced economies.

But it is necessary to take a step back from these immediate consequences. At $100 a barrel, oil is about a quarter below its inflation-adjusted price between 2011 and 2014. Additionally, oil futures prices are below spot prices, suggesting that the market expects this increase to be temporary. Central banks could therefore largely weather events in Ukraine, neither delaying the tightening nor accelerating it in response to rising headline inflation. And global stock markets are still up over the past year.

Likewise, although the Russian stock market has fallen significantly since the start of the invasion, Western sanctions are unlikely to have immediate dramatic effects. Sanctions rarely do this; they are simply not the economic equivalent of the bombs that Russia is currently dropping on Ukraine.

Moreover, Russia is better prepared than most countries to face sanctions. The country ran a huge current account surplus and accumulated record foreign exchange reserves of $630 billion, enough to cover nearly two years of imports. And while Russia depends on revenues from Europe, Europeans depend on Russian oil and gas – which may be even harder to replace in the short term.

But, in the longer term, Russia is likely to be the biggest economic loser from the conflict (after Ukraine, whose losses will go well beyond what can be measured in national accounts). Russia’s economy and the well-being of its people have stagnated since the Kremlin annexed Crimea in 2014. The fallout from its current large-scale invasion will almost certainly be more severe over time. Sanctions will claim more and more victims, and Russia’s growing isolation, as well as heightened investor uncertainty, will weaken trade and other economic ties. In addition, Europe can be expected to reduce its dependence on fossil fuels vis-à-vis Russia.

The longer-term economic consequences for the rest of the world will be much less severe than they are for Russia, but they will remain a persistent challenge for policymakers. There is a risk, albeit relatively unlikely, that the rise in near-term inflation will become rooted in increasingly less anchored inflation expectations and therefore persist. If that happens, the already difficult job of central banks will become even more complicated.

In addition, defense budgets are expected to increase in Europe, the United States and some other countries to reflect the increasingly dangerous global situation. It won’t reduce GDP growth, but it will reduce people’s well-being, because resources dedicated to defense are resources that cannot be spent on consumption or investment in education, health or infrastructure.

The medium and long-term consequences for the global economy of Russia’s invasion of Ukraine will depend on the choices. By invading, Russia has already made a terrible choice. The United States, the European Union and other governments have made initial choices on sanctions, but it remains to be seen how Russia will react to them or if new sanctions will be imposed. As sanctions and counter-responses intensify, the costs will be greater – first and foremost for Russia, but also to some extent for the rest of the global economy.

Global economic relations are positive-sum, and Russia’s growing isolation will remove a small positive. More broadly, uncertainty is never good for the economy.

But, as the world continues to react to the Russian invasion, worries about GDP seem small by comparison. Much more important is a world where people and countries feel safe. And it’s something worth paying for – even more than world leaders have paid so far.

Jason Furman, former Chairman of President Barack Obama’s Council of Economic Advisers, is a Professor of Economic Policy Practice at Harvard University’s John F. Kennedy School of Government and a Senior Fellow at the Peterson Institute for International Economics. © Syndicate Project, 2022