Initial conditions shape stagflation risk from geopolitical shocks
Identical geopolitical shocks produce substantially smaller stagflation risks when starting from a stable baseline, according to research by Maximilian Schröder. The paper models monthly euro area and U.S. transmission across two distinct economic starting points.
Two starting points, two divergent risks
Author Maximilian Schröder applies the geopolitical shock observed before Russia's invasion of Ukraine in January 2022 to two baseline environments: January 2022 and December 2025.
In both the euro area and the United States, the December 2025 environment displays a markedly lower increase in stagflation risk, defined as annual inflation exceeding 2 percent alongside negative industrial production growth.
While the January 2022 shock induced persistent shifts toward adverse tail risks, the same disturbance applied to December 2025 yields more contained probability shifts.
In the euro area, industrial production contracts persistently in the high-volatility regime, whereas the U.S. activity response is muted, partly due to domestic energy production and defense spending offsets.
Endogenous gates replace fixed scenarios
The econometric framework merges a regime-dependent mixture vector autoregression with endogenous state probabilities and heteroskedastic shock identification.
Using a 7-variable system with 12 lags spanning 1976 to 2025 for the U.S. and 1999 to 2025 for the euro area, the model allows shocks to alter both macroeconomic trajectories and the likelihood of entering a high-volatility regime.
Identification combines non-proportional variance shifts across states with sign and narrative restrictions anchored to events like the 2008 Lehman collapse and 2001 terrorist attacks.
Context matters more than shock size
Central banks often err by transposing historical shock playbooks onto new crises without considering differing starting conditions.
The framework proves that resilient baseline fundamentals substantially insulate economies against adverse geopolitical tail risks.
Policymakers must move beyond static point forecasts.