The Russian invasion of Ukraine has triggered the largest humanitarian crisis in Europe since World War II. Already, thousands of lives have been lost and millions of livelihoods have been destroyed through displacement, loss of homes, and loss of income. Like so many others, we are shocked by the unfolding humanitarian tragedy and the consequences of this brutal war.
Initial economic scenario for the eurozone
Here we focus on the Eurozone, the world's largest macroeconomy, which is particularly exposed to the conflict. We are aware that in Eastern European countries will feel direct and significant effects of the economic disruptions as well as the burgeoning refugee crisis. We use GDP to measure livelihood impacts, as income is a key component of GDP. As is common in scenario analyses, all point estimates in our calculations are not forecasts, but merely the midpoint of a range of possible outcomes.
Severe, escalating disruption with moderate policy response.
In this scenario, a protracted conflict exacerbates the refugee crisis in Central Europe. Western countries and Russia further expand sanctions, leading to a halt in oil and gas exports from Russia to Europe. European gas prices double to $70 per MMBtu in 2022 from an already high level of around $30, and the price of Brent crude oil jumps to $140 per barrel.
Overall inflation in the eurozone rises to more than 7 percent a year. The continent can replace part of its natural gas deficit with spot market purchases and a slower shift away from coal. Producing and consuming countries can build new liquefied natural gas (LNG) export and import infrastructures over time, but in the short term, higher prices, lower real incomes, and reduced consumer spending will lead to some demand shortfall.
Combined with the collapse in confidence we are already seeing, the eurozone tips into recession in 2022 and 2023. Growth falls to -0.5 percent in both years; growth in Germany is weaker at -1.4 percent because it is more dependent on natural gas. By mid-2023, the weak economy dampens demand; energy prices fall from their peak, significantly weakening inflation. In early 2024, GDP growth picks up as consumer spending and business investment recover, even as the low-intensity conflict in Ukraine continues. By the end of 2024, employment finally regains the ground it has lost since 2019, and growth returns to long-term pre-pandemic trends.
Impact on other major economies
Of course, the nature of the disruption and the ability of governments to respond will vary from country to country, and we can expect a wide range of scenarios. In any scenario, growth in major economies such as China and the United States will be less directly affected than in the eurozone. Two questions arise. Will the war in Ukraine shake consumer and business confidence? What will be the impact of higher commodity prices?
In the United States, the key question will be how the Federal Reserve responds to the impact of the oil price spike and the jump in agricultural, mining and mineral commodity prices (U.S. natural gas prices are largely independent of Europe). Under more normal circumstances, the Fed would probably not respond to supply-driven inflation surges, preferring to ensure that growth does not stall. But inflation in the United States is already uncomfortably high. On March 16, 2022, the Fed raised its short-term interest rate by 25 basis points, the first increase since December 2018. In its statement, the Fed also said it "anticipates that further increases in the target range will be appropriate." Market observers widely agree that even larger increases of 50 basis points are likely. It appears that the invasion of Ukraine will only slow the pace of rate increases, not change the course of policy in the United States.
The main impact in China is likely to come from increases in the prices of globally traded commodities; indirect effects such as reduced demand from trading partners will also play a role. Consumer sentiment in China itself is likely to be less affected.
Implications for business leaders
The speed of this crisis has confused many business leaders. The fog of war makes it difficult to understand exactly what is happening at the moment, let alone find a way forward. However, many companies must decide how to act both now and in anticipation of longer-term disruptions, particularly those we described at the outset.
Not every company is affected in the same way. Companies operating in Ukraine or Russia will be most directly affected. Right now, most of these companies are very busy protecting the lives of their employees. For other companies, the geographic location, scale of operations and industrial sector will determine the extent to which the war will affect their business. This crisis is structurally different than the pandemic. For businesses outside the war zone, the threats to employees' lives are less immediate. Their near-term challenges are more about the impact of sanctions and compliance challenges, the posture toward Russia they choose to adopt, and, especially for manufacturing companies, the impact of inflation on costs and supply continuity issues.
After several months of rising inflation in much of the world, another rapid increase in commodity prices is particularly worrisome. It will push overall inflation even higher and prolong the period of elevated inflation. Our conversations with executives around the world suggest that a concerted, company-wide effort is the only appropriate response. Leading companies are tackling inflation simultaneously in procurement, pricing, supply chain, workforce, and finance functions. Leaders can take their cues from the extent to which their organizations are exposed to the forces emanating from this crisis. All executives should build a picture of the scenarios that matter to them and develop models that reflect their industry and their own circumstances. Leaders concerned about major impacts can reactivate proven tools from recent major crises, such as nerve centers and plan-ahead teams.
One key difference between this crisis and COVID -19 is that today the world suffers supply shocks (which could be followed by demand shocks), while in March 2020 it was the other way around. Forward-looking planning teams should start by modeling today's supply shocks. These cross-functional teams can also help avoid decision-making errors and other crisis management pitfalls under high uncertainty, while supporting longer-term resilience.
The above scenario suggest that Europe and the global economy - from a macroeconomic perspective - can only withstand a limited disruption, but this window of opportunity will not remain open for long. We hope this will help you and your organization weather a confusing and challenging time. At the same time, we are aware of their shortcomings. They do not consider the extraordinarily long and thick tail of risks implicit in most wars.
This war has already caused devastation and suffering. This time is a reminder of times in Europe that we all thought were long gone. For the sake of the people we very much hope that this conflict will soon end.