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Chief Economist: Russia’s Invasion of Ukraine Ruined Global Order Overnight

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by VBL
Tuesday, Apr 05, 2022 - 14:40

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Chief Economist's Corner: The war in Ukraine hits the economy and leads to a new world order

Authored by Helge J. Pedersen Submitted by GoldFix Substack Posted without comment.

[T]here is hardly any doubt that we are again facing a time of upheaval in the global world order.

 

Everything seemed fine. Spring was coming, the pandemic was about to end and the Danish economy was in the middle of a solid upturn, with labour shortages as the biggest problem. But then Russia’s invasion of Ukraine ruined the global picture overnight.

Obviously, the colossal humanitarian costs caused by the war are by far the worst consequences. But the situation also casts dark shadows over the economic outlook.

First and foremost in the form of higher prices and shortages of energy and commodities, of which Russia is normally a major seller in the world market. That includes goods which are not subject to the sanctions policy of the Western countries or Russia’s own export ban as the exclusion of many Russian banks from the SWIFT system in practice makes cross-border payment transactions impossible. Also, at the moment a large part of Ukraine’s economy is not operating. This exacerbates the problems as Ukraine has large-scale production of essential goods and many companies which are important subcontractors, for example to the car industry. This will result in long delivery times for many consumer goods in the coming period.

Secondly, consumer and business confidence will be hit by general uncertainty and high inflation. This could result in lower spending and investment activity. An effect that could be fueled by the widening risk premiums on financial assets triggered by the fighting. And when global economic growth falls, foreign trade will also be hit. So this is one long negative chain reaction.

It is enormously difficult to make a quantitative estimate of the economic consequences of the war. But a number of central banks and institutions have set up scenarios for developments. The OECD assesses that economic growth in the Euro area will be reduced by nearly 1½% points compared to a situation without war, and the ECB’s calculations suggest broadly the same result. In Denmark, the scenarios set up by the Danish central bank and the government unambiguously point to weaker growth, higher unemployment and higher inflation than in the initial situation. But neither of them predicts a major and long-lasting economic downturn as a result of the war.

This is, obviously, good news. But don’t forget that these are hypothetical scenarios simulated using an economic model which is basically not designed to predict developments in a war situation. This means that the uncertainty associated with the calculations is significantly greater than normal. Things may turn out better than anticipated if the fighting is suspended soon. But they may also turn out far worse if the war drags on and in a worst-case scenario spreads beyond Ukraine.

Yet it also means that there is every reason to keep all doors open for easing economic policy if we face a new recession. And as most of the world’s central banks are busy fighting inflation, which is far too high, by tightening monetary policy, it mainly comes down to fiscal policy.

Many countries are starting to support households’ purchasing power, for example by cutting VAT and duties on energy, increasing tax deductions for transport, compensating businesses for energy bills or even capping prices of gas and electricity. So far the Danish government has only adopted the so-called heating package, providing heating subsidies for low-income households, but the tools are known if additional measures are required.

At the same time defence budgets are being increased markedly in the Western countries, and the ground-breaking decision to make the EU independent of Russian energy means that the green transition will be accelerated. That will also boost demand and create jobs.

While there is considerable uncertainty over the economic consequences of the war in Ukraine – apart from higher inflation and lower growth short term – the war will clearly change some of the fundamental structures in society. Security policy has become of paramount importance, and this will be reflected in the composition of demand for goods and services over the coming years. And there is no doubt that the relationship – and thus also economic relations – with Russia will remain at freezing point for many years, even if a peace agreement is reached soon. And although there will not be a new Cold War, based on a bipolar balance of power as we knew it from 1945 until 1991, there is hardly any doubt that we are again facing a time of unrest and upheaval in the global world order. Which side in the current conflict China will choose to support can be completely decisive for all of us many years ahead. Source Article

About: Helge J. Pedersen is MSc. Econ. from Copenhagen University, has more than 30 years experience in the financial sector and has been Group Chief Economist with Nordea since 1999.

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