In a globalized economy, geopolitical tensions are influencing economic and financial markets. Conflicts between major world powers, regional power struggles and territorial disputes can have far-reaching impacts spanning the globe, affecting growth, inflation and financial markets as well as supply chains. Whether due to competition for natural resources or ideological differences, these risks may trigger political instability and impede the economic progress of nations.
A geopolitical shock that impacts the availability of critical commodities can wreak havoc on business operations and investment. For example, a war in the Caucasus over the Nagorno-Karabakh dispute involving Armenia and Azerbaijan could disrupt international trade, leading to commodity prices volatility. Similarly, the Israel-Palestine and Russia-Ukraine conflicts have fuelled energy price volatility and impacted supply chain sourcing. Moreover, a military conflict in a country with key sea ports would likely result in shipping delays or the need to divert maritime resources from other areas of the globe. Consequently, these events will inevitably have an impact on investor confidence and monetary policies, and ultimately affect the world economy.
While many countries benefit from diversified supply chains that allow them to mitigate these effects, the broader impact of geopolitical shocks is difficult to measure. Nevertheless, a recent experimental study conducted by Bloom, Fuceri and Federle (2024) using CES 2023 data suggests that a three year or longer prolongation of military conflict would lead to higher goods prices in euro area countries. This effect is more pronounced in Greece and France, but the overall increase in prices is quite small.