The cost of “defending freedom” in Ukraine

Americans may be tempted to view the war in Ukraine as an unfortunate but distant crisis. As an economist, I know that the world is too connected for the United States not to be affected.

On February 22, 2022, President Joe Biden warned Americans that a Russian invasion of Ukraine, and US efforts to thwart or punish it, would come at a price.

“Defending freedom will have costs, also for us and here at home,” Biden said. “We have to be honest about it.” His statement came a day before Russian President Vladimir Putin ordered an attack on targets across Ukraine, including western parts of the country.

Now that war has broken out, the biggest costs to the US will likely be higher prices, on top of what is already the fastest pace of inflation in 40 years.

How much worse inflation could get will depend on how far Putin goes, the severity of the sanctions imposed on Russia and how long the crisis lasts. Will Putin cut off oil or gas to Europe? Will the invasion completely disrupt Ukraine’s ability to export food and other products to the rest of the world?

We know that Russia is one of the world’s largest energy exporters and Ukraine’s nickname is the “breadbasin of Europe”. And beyond that, the crisis has been rattling markets for months, sending the price of oil and other commodities skyrocketing.

These higher prices will trickle down to Europe, of course, but also to many other countries, including the US, making the Federal Reserve’s job of fighting inflation that much harder and posing a greater threat to the economy. .

pain at the pump

The most obvious costs to Americans will be at the gas pump.

Russia produces approximately 12% of the world’s oil and 17% of its natural gas. That makes it the world’s third largest oil producer and second largest gas producer. It is also Europe’s largest supplier of natural gas, getting almost half of its supply from Russia.

The risk is that Russia could cut off gas or oil supplies to Europe or other countries that issue sanctions or condemn its actions in Ukraine.

Europe may face the most immediate effects if some of Russia’s energy supplies are removed from the world market, which is why the US has been trying to assure allies that it can supply them with liquefied natural gas to make up any shortfalls. But world oil markets tend to be highly integrated, so the United States will not be immune.

The crisis has already pushed up the price of oil to the highest level since 2014, when Russia annexed Crimea from Ukraine, driving the average price of gasoline in the US to more than $3.50 a gallon.

The most serious sanction implemented against Russia so far is Germany’s freezing of the Nord Stream 2 pipeline, which would have transported liquid natural gas from Russia to Western Europe without going through Ukraine.

A disruption in a regional market will eventually affect the world market. Since the invasion, crude oil prices have soared above $100 and are likely to rise further.

Higher prices in the supermarket.

While Russia is a major fuel producer, Ukraine is a major food exporter.

Ukraine produces 16% of the world’s corn and 12% of the wheat, as well as being a major exporter of barley and rye.

While many of Ukraine’s exports go to countries in Europe and Asia, agricultural products, such as oil, tend to be traded in increasingly integrated global markets. Once again, the implication for US consumers is that while Europe could be hit more immediately in terms of shortages, prices are likely to rise everywhere.

US grocery prices rose 7.4% in January from a year earlier. Because the demand for food is generally not very sensitive to changes in price (people need to eat regardless of the cost), an increase in the cost of producing food is generally passed on to consumers.

The biggest risk to the US economy

That brings us to the Federal Reserve.

The US central bank is very concerned about the pace of inflation in the US and plans to raise interest rates to combat it. What is happening in the Ukraine could complicate their plans. If the crisis in Ukraine adds to the upward pressure on prices, that may fuel inflation and could force the Fed to take more drastic action.

Some economists believe that the US could soon see inflation of 10%, up from 7.5% today, in the event of a full-scale invasion, such as the one we are witnessing now. The United States has not seen inflation this high since October 1981.

The Ukrainians themselves, of course, will pay the highest costs of the Russian invasion.

If the Fed decides it has to act more forcefully to rein in inflation, that would not only raise borrowing costs for businesses and consumers, affecting everything from business loans to mortgages to student debt, but could put the economy at risk of recession.

At the same time, the crisis could have a dampening effect on interest rates. In times of crisis and uncertainty, investors often move their money into the safest assets they can find, on the so-called flight to quality. US government bonds and other dollar-denominated assets are often considered the safest, and increased demand for these assets could result in lower interest rates.

The Ukrainians themselves, of course, will pay the highest costs of the Russian invasion, in terms of loss of life, economic costs, and potentially the loss of their government. But the conflict, however distant it may seem, will have an impact on people everywhere. And the hit to the pockets of Americans may be closer than you think.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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