How invasion may hit U.S., global economies

GAZETTE: What does this do to global energy markets? Is there potential for a 1970s-level energy crisis, as some fear?

ROGOFF: It’s very different. The U.S. has enormous capacity; we’re a major producer of gas and oil. At the same time, we have become much more energy-efficient. But in tackling environmental issues, the West has in some ways made itself more vulnerable. Germany’s decision to shut down all its nuclear reactors and rely more on Russian gas is looking to be a mistake of historic dimensions. President Biden’s decision to shut down the Keystone pipeline made environmental sense, but the timing has turned out to be awkward. We are going to need to ship more liquified natural gas to Europe in the long run, and they’re counting on some help now, which is going to affect gas heating prices here in the U.S. Gas at the pump is going to easily hit $4 and higher. Unfortunately, as the war deepens, and as the U.S. and Europe strike back with ever-greater sanctions, we are likely to feel it even more acutely. Probably the single biggest downside for Americans is the risk of cyberwar if Russia bites back at our sanctions.

GAZETTE: The U.S., the U.K., and E.U. have already announced sanctions and taken other punitive measures against Russian banks, Russian-owned properties, and Russians close to Putin. More are expected. Russia has shown a willingness to use cyberwarfare to attack not only governments, but critical infrastructure, banks, and private businesses. Could heavy sanctions end up boomeranging on Europe and the U.S.?

ROGOFF: Since our leaders have talked so much about putting sanctions on, it will be worse if we don’t do it. They need to follow through. Otherwise, Putin will just keep ignoring everything they say. But on the other hand, it isn’t a stable equilibrium for us to try to have perma-sanctions and treat Russia like North Korea. They’re much too important. The sanctions themselves are not sufficient. The Russians have to believe that there will be a determined military response if they push into NATO countries.

GAZETTE: When and in what ways will American consumers start to feel the economic fallout?

ROGOFF: The immediate things they’ll feel are the stock market and higher energy prices. But the real concern would be that something hits us much faster, some kind of destabilization through cyberwar. We’ll feel the uncertainty immediately. The uncertainty may slow down our consumption, although nothing seems to have done that yet, even inflation. It could slow businesses down. The stock market falling certainly could slow down investment plans. So, you could have some macroeconomic impact from the uncertainty, no question about it.

GAZETTE: Will this situation impact the Federal Reserve’s planned interest rate hike next month?

ROGOFF: It is remarkable that the euro/dollar rate has barely budged, dropping only a percent or two so far, despite war in Europe. Interest rates haven’t moved that much, either. You get the feeling that the markets, even though there’s a lot of talk about invasion, are still very focused on the Federal Reserve. I agree with Larry Summers — that before this, the Fed was being very optimistic to believe that a 1.5 to 2 percent worth of interest rate hikes would be enough to tame inflation. This is going to slow the Fed hikes down, but not necessarily inflation. We are now even more likely to end up with inflation lasting longer because war in Europe will make the Fed’s job more difficult, no question. It is probably adding upside to inflation and downside to growth, so it’s not easy to face this.

GAZETTE: Are there secondary or tertiary effects we could experience over the long term?

ROGOFF: It may not happen right away, but surely the West, and especially Europe, is going to be radically ramping up their military expenditures. We’ve gone through this long period of a “peace dividend” where spending on military has been coming down since the end of the Vietnam War, and indeed, since World War II and the Korean War. Even an extra percent or 2 of GDP every year in higher military expenditures is going to be costly, and Europe may need to do more.

For the moment, Europe is still reeling from all their spending on the pandemic, including the sweeping next-generation euro spending, which effectively subsidized the debts of periphery Europe. I can imagine it is going to be difficult for them to digest the reality of needing to turn and spend the same again on building up their military and creating a coherent Europe defense strategy. This is not kind of productive infrastructure spending they want to be doing, nor do we, but Putin’s actions could also upend the fiscal debate here.