Ukraine Crisis and Actions of the Fed

We wrote a couple of months ago about the perils of taming inflation faced by the Federal Reserve. The difficulty of the Fed’s task in bringing down the worst inflation in forty years just got worse when Russia launched an all-out invasion to take over Ukraine. The Fed has announced that it expects to raise interest rates and finish its bond purchases in March. Now the question is how the Ukraine crisis and actions of the Fed will relate to each other.

How High will Higher Energy Prices Drive the Rate of Inflation?

The Russian invasion of Ukraine will result in higher energy prices. One issue is that oil and natural gas from Russia pass through Ukraine and could be interrupted by the fighting. The other is that as Europe, the USA, and much of the rest of the world shut off Russia from the global financial system they will only be able to sell their oil and natural gas to China. Crude oil prices began to climb as soon as Russia began its invasion. In an article about interest rates, inflation, and Ukraine, The New York Times quotes Alan Detmeister, a UBS economist, as saying that if crude oil hits $120 a barrel that US inflation will hit 9% instead of the currently-projected 8% before any Fed action. The situation is reminiscent of the 1970s when inflation was raging and was made worse by the Arab oil embargo and then the Iranian Revolution.

How Long Will the Ukraine Crisis Last?

After announcing a round of sanctions on Russian banks and more, President Biden was asked if the sanctions would make Putin stop the invasion. The answer was that sanctions would need time to work and Putin’s sense of righting the “wrong” of breaking up the USSR means that he will not stop the takeover of Ukraine. The invasion is likely to turn into an occupation and even to another invasion of the small country of Moldova which, like Ukraine, has a breakaway faction. Putin wants all of the former Eastern Bloc countries back in the fold but will soon find substantially greater NATO forces on his Eastern borders and a much more unified NATO ready to go to war if any of its members is attacked. This situation will easily last months if not years.

Will Fed Actions Work to Reduce Inflation?

The Covid pandemic caused a great amount of economic havoc on top of illness and deaths. The global supply chain has not recovered while demand for many goods is much higher as parts of the economy recover. This is a key factor in higher inflation and will make Fed actions of raising interest rates and cutting back on bond purchases trickier. The expected surge in oil and natural gas prices due to not buying from Russia falls into the same category. Raising interest rates will not serve to reroute oil from the US and Middle East to make up for shortfalls when supplies from Russia are cut off.

Ukraine Crisis and Actions of the Fed

Global Economic Fallout from the Ukraine Crisis

The immediate effects of Russia occupying Ukraine and sanctions by the US, EU, and allies like Japan and Australia will drive inflation up. But cutting Russia out of the global economy will likely cause a slowing of the global economy, especially in Europe. Thus timing of rate increases over the coming year may need to be adjusted so that higher interest rates do not bring the US economy down too quickly and cause a recession. The president of the Federal Reserve Bank of San Francisco, Mary C. Daly, said, “I see the geopolitical situation, unless it would deteriorate substantially, as part of the larger uncertainty that we face in the United States and our U.S. economy. We’ll have to navigate that as we go forward.”

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