Thedéen: Supply shocks create difficult policy trade-offs

Thedéen emphasized that adverse supply-side shocks, such as a sharp increase in oil prices, reduce economic activity while simultaneously pushing up inflation.

This stagflationary effect presents a more difficult dilemma for central bank policymakers compared to demand-driven inflation, which can be addressed by simply raising the policy rate.

The Riksbank Governor noted that if the inflationary impulse from a supply shock is expected to be short-lived, central banks can often 'see through' it.

However, a significant risk is that such impulses spread to other prices and expectations, leading to persistently high inflation.

The larger and longer-lasting the disturbance, the greater the risk of these spillover effects, making the policy response more critical and complex.

Geopolitical instability and climate change are likely to make negative supply shocks more common in the future, according to many economists.

The conflict in the Persian Gulf exemplifies a significant negative supply shock, impacting not only global oil production but also crucial products like fertilizers, plastic raw materials, and helium.

Thedéen noted that around 20 percent of the world's oil and much of the liquefied natural gas trade pass through the Strait of Hormuz, making disruptions in this region particularly impactful.

He stressed that the return to normal conditions will be protracted, even if the strait reopens, due to factors like mine clearance, massive ship queues, and damaged infrastructure.

This means inflationary pressures will fade slowly, with no immediate prospect of returning to pre-war conditions.

Historical data suggests that wars and geopolitical events tend to elevate inflation more significantly and for several years, unlike temporary disruptions such as a ship stuck in the Suez Canal.

The mechanism largely works via increased difficulty and cost in producing and transporting goods, creating shortages across various sectors.