War-related supply shocks complicate monetary policy
Erik Thedéen, Governor of the Riksbank, discussed the complex challenges for monetary policy posed by war-related supply shocks. Speaking at the Stockholm Chamber of Commerce, he highlighted the stagflationary effects of geopolitical instability and prolonged supply chain disruptions.
The stagflationary dilemma
Governor Erik Thedéen outlined the difficult trade-offs central banks face when economies are hit by supply-side shocks.
Unlike demand-driven inflation, negative supply shocks reduce economic activity while simultaneously pushing up prices, creating a stagflationary environment.
The conflict in the Persian Gulf serves as a significant example, disrupting global trade in oil, liquefied natural gas, and essential products like fertilisers and raw materials for plastics.
This region is critical, with around 20 percent of the world's oil production passing through the Strait of Hormuz.
Thedéen noted that even if the strait reopens, factors such as mine clearance, massive ship queues, and damaged infrastructure will lead to a protracted normalisation phase.
This means inflationary pressures will fade slowly, with no immediate return to pre-war conditions, making the central bank's task more challenging.
Beyond traditional oil shocks
Thedéen differentiated geopolitical crises from other supply disruptions, noting that historical data shows wars tend to push up inflation more significantly and persistently, often for several years.
Increased geopolitical threats can also lower economic growth and heighten inflation uncertainty.
He drew parallels to the 2021-2022 inflation surge, partly driven by Russia's invasion of Ukraine, which forced central banks to act.
While Sweden's current policy rate is higher and the krona has appreciated, making it less susceptible to immediate inflationary pressures than in 2022, Thedéen acknowledged that more expansionary fiscal policy and altered inflation perceptions could work in the opposite direction.
He also highlighted Sweden's lower oil dependence as an advantage, though its high foreign trade dependence means global inflation can still spill over.
Navigating an uncertain future
Thedéen's speech underscores the unenviable position of central banks facing prolonged, war-related supply shocks.
Policymakers must weigh the risks of acting too late against the dangers of unnecessary economic contraction, all while navigating a potentially new era of global instability.
This delicate balancing act demands nuanced strategies, emphasizing the critical importance of maintaining inflation target credibility amidst unprecedented external pressures.