{ "title": "Navigating Fragmentation, Conflict, and Large Shocks", "publication": "IMF News, June 21, 2024", "sourceUrl": "https://www.imf.org/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference", "canonical": "https://www.imf.org/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference", "overlayPath": "/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/index.md", "summary": "Gita Gopinath discusses the impacts of Russia’s invasion of Ukraine on Ukraine, neighboring countries, and the global economy at the NBU-NBP Annual Research Conference, highlighting increased fragmentation, higher defense spending, and implications for monetary policy in a more shock-prone environment. She emphasizes the need for central banks to adapt their strategies and the importance of coordinated fiscal, financial, and structural policies to support macroeconomic stability.", "publishDate": "2024-06-21", "sections": [ { "heading": "Introduction", "content": "- Focus: impacts of Russia’s invasion of Ukraine on Ukraine, neighboring countries, and the global economy; implications for monetary policy in a more shock-prone environment.\n- Key judgments:\n - The war is now in its third year.\n - The war has increased fragmentation pressures and raised defense spending.\n - Compared with decades of efficiency-driven economic integration, recent measures will likely make the global economy more shock-prone with higher inflationary pressures, reduced potential output growth, and precarious public finances.\n- Policy questions posed:\n - How should central banks conduct monetary policy in this more shock-prone environment?\n - What is the role of additional tools such as foreign exchange intervention?\n - How should fiscal, financial, and structural policies be deployed to support macroeconomic and financial stability?" }, { "heading": "Effects of war on Ukraine", "content": "- Macroeconomic outcomes and policy responses:\n - Strong global support and policies, including actions by the National Bank of Ukraine, helped Ukraine avoid deep macroeconomic instability and \"kept inflation from spiraling.\"\n - Output is roughly 25 percent below its pre-war level.\n - Much of the capital stock has been destroyed by war.\n - Ongoing help is needed; the Ukraine Recovery Conference in Berlin (June 11-12) discussed global assistance.\n- Recent policy moves noted:\n - Emergency monetary and FX policies: raising interest rates, fixing the hryvnia to the dollar, introducing FX and capital controls.\n - Use of some monetary financing to finance the war; negotiated official and private debt standstills; rationalized discretionary public expenditures.\n - Later steps: monetary financing ceased; exchange rate peg replaced by a managed float; FX controls cautiously eased.\n - Multiyear financing arrangement with the IMF anchors macro policy; a 4-year 50-billion euro Ukraine Facility with the EU; large contributions from the US and other partners." }, { "heading": "Wider impact of the war", "content": "- Inflation:\n - The war has been a major supply shock, especially for CESEE and other European countries reliant on Russian natural gas.\n - When gas stopped, energy prices skyrocketed, boosting inflation; disruptions in Ukraine’s grain exports contributed to food inflation.\n - CESEE experienced the largest inflationary impact over the past two years (see Figure 2).\n - Higher cumulative inflation rates in CESEE have left them with a potential competitiveness problem.\n- Growth:\n - The conflict has derailed recovery from the COVID-19 pandemic via adverse terms-of-trade effects and tighter monetary policy.\n - Trade has been hit, especially for CESEE countries with major trade links to Russia.\n - CESEE countries have experienced the biggest setbacks to growth performance since the onset of the war (see Figure 3).\n- Defense spending and public finances:\n - Defense spending is likely on a permanently higher trajectory.\n - Effects particularly pronounced in the CESEE region, especially the Baltics (see Figure 4).\n - Higher defense spending compounds fiscal pressures from COVID-19, green transition, and demographics, requiring difficult steps to keep debt sustainable." }, { "heading": "Turning point for geoeconomic fragmentation", "content": "- Acceleration of fragmentation:\n - Russia’s invasion of Ukraine has been a catalytic turning point accelerating geoeconomic fragmentation away from efficiency-based global trade.\n - Number of new trade restrictions in each of the last two years has tripled relative to 2019 (see Figure 5).\n- Trade and FDI realignment:\n - Trade has fallen much less between geopolitically aligned groups than between more divergent countries (see Figure 6); similar patterns for FDI.\n - Firms must now account for national-security constraints and geoeconomic uncertainties when structuring supply chains.\n- Macroeconomic model-based scenarios and risks:\n - April 2023 WEO model-based analysis suggests fragmentation could reduce the level of output in a bloc centered around China by over 3 percent in the long run (left-hand panel of Figure 7).\n - Financial fragmentation scenario: real interest rates in a U.S.-centered bloc could increase due to waning flows of savings from surplus economies in a China-centered bloc; some decline in real interest rates in the China bloc as they invest more domestically (right-hand panel of Figure 7).\n - Fragmentation can weaken risk-sharing and diversify less, leading to more volatile capital flows (left-hand panel of Figure 8); effects especially pronounced for emerging markets (right-hand panel of Figure 8).\n - Simulations where trade in commodity groups is banned between blocs show large first-year inflation impacts for some commodities and blocs (Figure 9).\n- Implication: a less integrated global economy will be poorer and more shock-prone, reinforcing the need for policy preparedness." }, { "heading": "Implications for monetary policy", "content": "- General implications:\n - A more fragmented global economy implies inflation will deviate from target by larger magnitudes and for more prolonged periods.\n - Supply-driven shock volatility complicates tradeoffs for central banks between stabilizing inflation and employment; employment expected to be more volatile around potential.\n - Protracted high inflation can change transmission: \"intrinsic\" persistence in the Phillips Curve may rise via indexation and dislodged inflation expectations; nonlinearities may become pronounced in high-pressure, high-inflation environments.\n - Resulting asymmetry: large shocks may produce substantial upward skewness in inflation responses.\n- Policy rule considerations:\n - Forecast-based policy rules that set policy rates based on medium-term inflation forecasts have appeal but may perform poorly when uncertainties are large and asymmetric.\n - A risk-management strategy that accounts for tail risks is preferable to focusing heavily on a central forecast.\n- Model illustration and lessons:\n - A New Keynesian model with nonlinear Phillips Curve and endogenous indexation shows:\n - Cost-push shocks have small/transient effects when inflation near steady state, but large/persistent effects if shocks are persistent and indexation rises.\n - Policymakers must estimate persistence (Kalman filter); reacting only to medium-term forecasts can delay response and allow inflation to surge (Figure 10).\n - Reacting to realized core inflation preempts inflation surges but at some output cost (orange lines in Figure 10).\n - Practical implication: central banks must balance underreacting to persistent shocks against overreacting to transient ones; more focus on nearer-term forecasts and realized inflation may be warranted, accepting some short-run output/employment costs.\n - Anchoring medium- and long-term inflation expectations remains important but does not guarantee appropriate risk balance." }, { "heading": "Responding to higher capital flow volatility", "content": "- Emerging market concerns:\n - Capital flow volatility and exchange rates likely to be more volatile in a conflict-prone environment.\n - The Fund’s Integrated Policy Framework (IPF) helps identify when FX intervention (FXI) and inflow capital flow management measures (CFMs) may improve policy tradeoffs for EM central banks.\n- Guidance on FXI:\n - The bar for FXI should be set fairly high; flexible exchange rates desirable if FX markets are deep and financial stresses modest.\n - Stronger case for FXI if FX market depth is low and the economy faces external shocks with deteriorating investor sentiment and tighter financial conditions.\n - Central banks must consider intertemporal tradeoffs: supporting the exchange rate today may compromise future ability to provide FX liquidity, especially when reserves are limited and shocks may persist or intensify (a key risk in military conflicts)." }, { "heading": "Need for supportive financial, fiscal, and structural policies", "content": "- Financial stability and resilience:\n - Monetary tightening required to contain inflation may fuel financial market stress and risk \"financial dominance.\"\n - High premium on enhancing financial system resilience: deepen monitoring of financial risks, focus on the sovereign-bank nexus, nonbank risks, payments system risks (including cyber).\n - Ensure adequate prudential buffers; build capital where profits are strong.\n - Readiness for emergency liquidity assistance (ELA) and effective resolution strategies is essential.\n- Fiscal policy:\n - Responsible fiscal policy is critical: expansionary fiscal stances increase pressure on monetary policy and can amplify financial vulnerabilities and fiscal dominance risks.\n - Given potential ratcheting up of defense spending and refugee support, governments should balance needs by paring spending elsewhere while protecting vulnerable populations.\n- Structural reforms:\n - Structural reforms can strengthen potential output and shock resilience (Figure 11).\n - Larger, more economically integrated regions are less prone to shocks; deepening links with the EU is beneficial for non-EU European economies.\n - For the EU, moving closer to a true \"single market\" by lowering barriers to cross-border mobility in services, goods, and labor will add to strength and resilience.\n - Mobility on certain dimensions, especially labor, remains far below that in the United States." }, { "heading": "Closing remarks", "content": "- Early lessons from Ukraine’s response (preliminary assessment on four fronts):\n 1. Macroeconomic stability aligned with national security: rapid, tough, innovative decisions preserved core state functions—pensions paid, bank branches open, tax ratios remained high.\n 2. Agility and adaptability: monetary financing ceased; domestic bond market revitalized; domestic revenue mobilization and external debt restructuring underway; peg replaced by managed float; FX controls cautiously eased.\n 3. Coordination while maintaining independence: coordinated monetary and fiscal policy was and remains essential for a shock of this magnitude.\n 4. Resource mobilization and reforms: turned to external donors; multiyear IMF arrangement anchors macro policy; 4-year 50-billion euro EU Facility and large contributions from partners; sustained structural reforms to build institutions for post-war future.\n- Conclusion:\n - Singular focus on maintaining macro stability with policy agility, ownership, sustained reforms, and external support has supported Ukraine through wartime challenges and sets the stage for a robust recovery toward EU accession.\n - Policymakers must prepare to navigate a more volatile world shaped by fragmentation and conflict—central banks, fiscal authorities, and structural reform agendas all have critical roles.\n\nRemarks by Gita Gopinath, IMF First Deputy Managing Director, at the NBU-NBP Annual Research Conference, June 21, 2024.\n\n---\n\n\n References\n\n- Gita Gopinath\n- Speeches\n- PRESS CENTER\n- A quantitative microfounded model for the Integrated Policy Framework\n- Second-round effects of oil price shocks – implications for Europe’s inflation outlook\n- Integrated monetary and financial policies for small open economies\n- An Integrated Policy Framework (IPF) diagram for international economics\n- Is high debt constraining monetary policy? Evidence from inflation expectations\n- Shocks and Capital Flows: Policy Responses in a Volatile World\n- An estimated DSGE model for integrated policy analysis\n- Changing global linkages: a new cold war?\n- The shifting and steepening of Phillips curves during the pandemic recovery: international evidence and some theory\n- World Economic Outlook: A Rocky Recovery. April 2023\n- Global Financial Stability Report: Safeguarding Financial Stability amid High Inflation and Geopolitical Risks. April 2023\n- World Economic Outlook: Navigating Global Divergences. October 2023\n- Integrated Policy Framework – Principles for the Use of Foreign Exchange Intervention\n- https://www.imf.org/en/home\n\nSource: https://www.imf.org/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference" } ], "bullets": [ "[Markdown version](/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/index.md)", "[Structured JSON version](/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/index.json)", "[Bundle manifest](/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/bundle-manifest.json)", "Published: June 21, 2024", "Focus: impacts of Russia’s invasion of Ukraine on Ukraine, neighboring countries, and the global economy; implications for monetary policy in a more shock-prone environment.", "Key judgments:", "Policy questions posed:", "Macroeconomic outcomes and policy responses:", "Recent policy moves noted:", "Inflation:", "Growth:", "Defense spending and public finances:", "Acceleration of fragmentation:", "Trade and FDI realignment:", "Macroeconomic model-based scenarios and risks:", "Implication: a less integrated global economy will be poorer and more shock-prone, reinforcing the need for policy preparedness.", "General implications:", "Policy rule considerations:", "Model illustration and lessons:", "Emerging market concerns:", "Guidance on FXI:", "Financial stability and resilience:", "Fiscal policy:", "Structural reforms:", "Early lessons from Ukraine’s response (preliminary assessment on four fronts):", "Conclusion:", "[Gita Gopinath](https://www.imf.org/en/about/senior-officials/bios/shirin-hamid)", "[Speeches](https://www.imf.org/en/news/searchnews)", "[PRESS CENTER](http://presscenter.imf.org/)", "[A quantitative microfounded model for the Integrated Policy Framework](https://www.imf.org/en/Publications/WP/Issues/2021/12/17/A-Quantitative-Microfounded-Model-for-the-Integrated-Policy-Framework-510977)", "[Second-round effects of oil price shocks – implications for Europe’s inflation outlook](https://www.imf.org/en/Publications/WP/Issues/2022/09/06/Second-Round-Effects-of-Oil-Price-Shocks-Implications-for-Europes-Inflation-Outlook-523201)", "[Integrated monetary and financial policies for small open economies](https://www.imf.org/en/Publications/WP/Issues/2023/08/04/Integrated-Monetary-and-Financial-Policies-for-Small-Open-Economies-537587)", "[An Integrated Policy Framework (IPF) diagram for international economics](https://www.imf.org/en/Publications/WP/Issues/2024/02/23/An-Integrated-Policy-Framework-IPF-Diagram-for-International-Economics-545125)", "[Is high debt constraining monetary policy? Evidence from inflation expectations](https://www.imf.org/en/Publications/WP/Issues/2023/06/30/Is-High-Debt-Constraining-Monetary-Policy-Evidence-from-Inflation-Expectations-534708)", "[Shocks and Capital Flows: Policy Responses in a Volatile World](https://www.elibrary.imf.org/display/book/9798400211263/9798400211263.xml)", "[An estimated DSGE model for integrated policy analysis](https://www.imf.org/en/Publications/WP/Issues/2023/06/29/An-Estimated-DSGE-Model-for-Integrated-Policy-Analysis-535436)", "[Changing global linkages: a new cold war?](https://www.imf.org/en/Publications/WP/Issues/2024/04/05/Changing-Global-Linkages-A-New-Cold-War-547357)", "[The shifting and steepening of Phillips curves during the pandemic recovery: international evidence and some theory](https://www.imf.org/en/Publications/WP/Issues/2024/01/12/The-Shifting-and-Steepening-of-Phillips-Curves-During-the-Pandemic-Recovery-International-543712)", "[World Economic Outlook: A Rocky Recovery. April 2023](https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023)", "[Global Financial Stability Report: Safeguarding Financial Stability amid High Inflation and Geopolitical Risks. April 2023](https://www.imf.org/en/Publications/GFSR/Issues/2023/04/11/global-financial-stability-report-april-2023)", "[World Economic Outlook: Navigating Global Divergences. October 2023](https://www.imf.org/en/Publications/WEO/Issues/2023/10/10/world-economic-outlook-october-2023)", "[Integrated Policy Framework – Principles for the Use of Foreign Exchange Intervention](https://www.imf.org/en/Publications/Policy-Papers/Issues/2023/12/20/Integrated-Policy-Framework-Principles-for-the-Use-of-Foreign-Exchange-Intervention-542881)", "[https://www.imf.org/en/home](https://www.imf.org/en/home)" ], "alternates": { "markdown": "/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/index.md", "json": "/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/index.json", "bundleManifest": "/en/news/articles/2024/06/21/sp062124-fdmd-nbu-nbp-annual-research-conference/bundle-manifest.json" }, "generatedAtUtc": "2026-09-26T03:07:33.308Z" }