Goldman Sachs tip for measuring U.S. inflation & GDP impact of Russia’s Ukraine invasion

Russia-Ukraine tensions have pushed the Fed’s geopolitical risk index to a very high level. Any direct effects on the US economy should be limited because trade links are weak and energy prices are likely to be affected far less in the US than in Europe. Our rules of thumb imply that a $10/bbl increase in the price of oil boosts US core inflation by 3.5bp and headline inflation by 20bp, but lowers GDP growth by just under 0.1pp. The growth hit could be somewhat larger if geopolitical risk tightens financial conditions materially and increases uncertainty for businesses.

The combination of upside inflation risk and downside growth risk has mixed implications for monetary policy. Historically, Fed officials have sometimes preferred to delay major policy decisions until uncertainty surrounding geopolitical risks diminished. In some cases, such as after September 11 or during the US-China trade war, the FOMC has cut the funds rate.

The current situation is different from past episodes when geopolitical events led the Fed to delay tightening or ease because inflation risk has created a stronger and more urgent reason for the Fed to tighten today than existed in past episodes. With some signs of problematic wage-price dynamics emerging and near-term inflation expectations already high, further increases in commodity prices might be more worrisome than usual. As a result, we do not expect geopolitical risk to stop the FOMC from hiking steadily by 25bp at its upcoming meetings, though we do think that geopolitical uncertainty further lowers the odds of a 50bp hike in March.