Ukraine War a Serious Threat to the US Economy?

The rise in fuel costs since the start of the Ukraine crisis is only one reason that might have pushed the March inflation rate beyond 8%.

Many experts discounted the ramifications of Vladimir Putin’s assault on Ukraine three weeks ago, even though the US economy had entered 2022 at an enormous pace. “The economic impact of the Russian assault on the United States will be marginal,” stated the chief economist of an Analytics firm. However, there has been a reevaluation since then. Late last week, an expert economics team predicted that US GDP could rise by only 1.75 percent from the fourth quarter of last year to the fourth quarter of this year, a dramatic drop from the 5.7 percent predicted in 2021. Another specialist team also anticipated that the economy would enter a recession anytime in the following twelve months, possibly between 20% and 35%. A recession is defined as two consecutive quarters of negative GDP growth.

Several factors have contributed to this shift in tone. The conflict appears to be dragging on; the US and its allies have retaliated against Putin’s aggressiveness with unprecedented economic penalties; and the price of oil has risen to around $100 per barrel, with the likelihood of greater hikes in the months ahead. According to the American Automobile Association, gas prices have soared to a national average of $4.33 per gallon and have surpassed seven dollars in some areas of California. Increased energy prices operate as a tax on the economy, lowering demand for other products and services. They also contribute to a rise in overall consumer price inflation, which is already at its highest level in forty years: 7.9% in February. The sharp rise in fuel prices since the start of the Ukraine crisis may easily push the March inflation rate beyond 8%.

The Russian invasion of Ukraine is a negative supply shock in economic terms, as it disrupts output and boosts prices. However, assuming the crisis does not spread beyond Ukraine, the supply shock is unlikely to damage the US economy, which grew briskly in 2021 despite substantially rising oil prices without any help from Russia. The Ukraine supply shock comes on top of a worldwide supply shock caused by the coronavirus epidemic, which closed industries, clogged international supply chains, and boosted the price of everything from old vehicles to fried chicken. This series of adverse events has drawn similarities to the 1970s when an oil price shock paired with domestic pricing pressures resulted in stagflation and recession. Last Monday, a specialist at macroeconomic research described the fight in Ukraine as a “global stagflationary shock.” He correctly observed that Europe was the region most affected by the earthquake. However, the United States is not immune to it.

The Feds had already determined that the fear of rising inflation warranted reducing some of the unprecedented monetary support they had provided the economy during the epidemic even before the conflict began. Accordingly, they plan to hike the federal funds rate from zero to 0.25 percent at a policy meeting this week for the first time since 2018. A 0.25 percent funds rate would be historically low, but market experts expect six further rate rises in 2022 or one per policy meeting. Other interest rates throughout the economy, such as house mortgages and car loans, are anticipated to climb when the federal funds rate rises. If the Fed’s increase in borrowing costs works as planned, it would gradually curb consumer spending and lower inflation—a scenario known as a soft landing by economists. However, this happy ending is not assured. When the Fed has raised interest rates to combat inflation, it has occasionally thrown the economy into recession.

The repercussions of the Ukraine conflict make a smooth landing even more difficult for the Fed. By 2022, some of the supply-chain issues created by the outbreak looked to be fading, and many analysts predicted that inflation would peak in February or March before declining sharply. That schedule has since been put into doubt, albeit not completely debunked. In certain locations, the Consumer Price Index for February showed price increases easing or even reversing, according to last week’s data. The price of old automobiles and trucks, for example, had increased by more than 40% in the previous year. However, that index fell by 0.2 percent last month.

Despite what is occurring in Ukraine and in the oil markets, several analysts remain confident that overall inflationary pressures will begin to ease shortly, citing these factors. On Friday, the chief economist of a macroeconomics firm wrote to his clients, “The year-over-year rate will creep up by another tenth in March, but it will start to decrease fast when the anniversary of last spring’s increase in used car prices approaches.” In the long run, experts concluded, what occurs in the labor market will be the most critical element in determining the course of inflation. Businesses will have less motivation to raise prices if pay growth is low and worker productivity rises, reducing the risk of a wage-price spiral, which the Fed fears the most. According to experts, “labor market indicators are pretty optimistic” from an inflation standpoint. According to the Labor Department’s jobs report, despite this resilience, average hourly wages hardly changed in February. Payroll employment increased by 678 thousand, and the unemployment rate fell to 3.8 percent.
Other economists, including some Democrats, are less enthusiastic about the inflation prognosis as the Ukraine crisis affects the price of wheat and other commodities outside oil. Last week, renowned market advisors pointed out that, while some economic models predict lower inflation, they failed to predict what happened last year. Many businesses plan to raise prices even higher, citing rising costs. To this point, major corporations such as Starbucks, Kraft, and Norwegian Cruise Line have announced price increases this year.

Experts also noted more important things than inflation, such as defending democracies against unjustified assaults. They expressed strong support for President Biden’s restriction on Russian energy imports, even if it results in higher gas costs and inflation pressure. It was Biden’s viewpoint when he admitted that prohibiting Russian energy imports would cost the US money. How much will these expenses be? Oil prices plummeted by more than 10% in the three days after Biden’s remark, serving as a timely reminder that making economic forecasts is risky. That was a positive development, but the longer the war continues, the higher the economic consequences will be—for all sides.