Impact of geopolitical surprises on euro area inflation varies case by case

Abstract

Monetary policy decision-making now includes consideration of geopolitics as a factor that can create volatility in inflation rates. However, geopolitical surprises and their consequences are not particularly well understood yet in economics. Our empirical analysis focuses on two events that have substantially increased geopolitical risks: Russia’s invasion of Ukraine and the Israel-Hamas conflict. We estimate that Russia’s invasion of Ukraine added more than 2 percentage points to euro area inflation and reduced the euro area’s gross domestic product (GDP) in 2022 by as much as 1%. By contrast, our analysis indicates that the outbreak of the Israel-Hamas conflict actually reduced euro area inflation. Our findings show that a rise in geopolitical uncertainty has a contractionary effect on euro area output, but the impact on inflation varies on a case-by-case basis.