How distant conflicts affect domestic wallets
This paper by Yuriy Gorodnichenko, Dimitris Georgarakos, Geoff Kenny, and Olivier Coibion provides empirical evidence that geopolitical risk can have negative economic consequences through expectations channels even before conflicts directly impact the domestic economy. The authors utilize data from the European Central Bank’s Consumer Expectations Survey (CES) across three waves: September 2024, December 2024, and March 2025, covering 11 eurozone countries. Gorodnichenko et al. introduced novel hypothetical scenario questions that randomly assigned different conflict durations (short, medium and long duration) to survey respondents, creating exogenous variation in perceived geopolitical risk. Finally, they employed ordered logit regressions to analyze how conflict duration affects consumer expectations across ten economic dimensions, including inflation, unemployment, economic growth, stock prices, government debt, and personal financial well-being.
Findings
Longer conflict durations lead consumers to expect stagflationary conditions:
- Inflation expectations increase by almost 50 percentage points when conflicts are expected to last 3+ years
- Unemployment expectations rise significantly with longer conflict durations
- Economic growth expectations decline by nearly 40 percentage points for extended conflicts
Consumers anticipate that prolonged geopolitical risk will result in:
- Lower stock prices and reduced trade volumes
- Higher government debt levels despite expectations of increased taxes
- Minimal effects on housing prices
Extended conflict durations cause households to expect deterioration in their personal financial situation. The effects are more pronounced among:
- Non-liquidity constrained households (those who can cover unexpected monthly expenses)
- More attentive consumers (those paying greater attention to geopolitical news)
The study demonstrates clear negative effects on consumption:
- Longer conflict expectations lead to reduced real consumption expectations
- Panel data analysis shows a 0.7 percentage point decrease in nondurable spending per unit increase in geopolitical concerns
- Durable goods spending exhibits even stronger responses, with approximately 4.5% decrease per unit increase in concerns
- The probability of purchasing big-ticket items falls by 1.2 percentage points
Geopolitical concerns vary across populations:
- Southern European countries (Greece, Italy, Portugal) show higher concern levels than Northern European countries
- Female, older, and more educated respondents tend to express stronger concerns
- 75% of respondents pay at least some attention to geopolitical events, with 41% paying much or great attention
The Impact of Geopolitical Risk on Consumer Expectations and Spending
Authors: Yuriy Gorodnichenko, Dimitris Georgarakos, Geoff Kenny, Olivier Coibion
From: UC Berkeley, ECB, University of Texas – Austin
The size of geopolitical shock matters
This ECB working paper by Davide Brignone, Luca Gambetti, and Martino Ricci represents the first comprehensive examination of non-linearities in geopolitical risk (GPR) shock transmission. While all previous studies on geopolitical risk relied exclusively on linear frameworks, the authors investigate whether larger positive GPR shocks have disproportionately greater economic impacts through non-linear amplification mechanisms. The authors employ a novel two-step econometric framework combining structural vector autoregressive (SVAR) models with Vector Autoregression with Exogenous variables (VARX) methodology. They use monthly U.S. data spanning from January 1970 to December 2023, encompassing the Geopolitical Risk Index, CBOE Volatility Index (VIX), S&P 500 stock market index, Industrial Production, Consumer Price Index (CPI), Real Consumption Expenditure, and Federal Funds Rate.
Findings
- Non-linear effects and size dependency
The research reveals that the magnitude of geopolitical shocks fundamentally determines their economic impact. Small shocks of around two standard deviations exhibit minimal differences between linear and non-linear models, suggesting that traditional linear approaches remain adequate for modest geopolitical events. However, as shock magnitude increases to four and eight standard deviations, substantial non-linearities emerge that dramatically amplify economic impacts. For the largest shocks (8 standard deviations), the VIX increases by 14 points compared to minimal increases in linear models, equity prices decline by 10%, and real consumption drops by nearly 2%.
- Uncertainty as the primary transmission channel
The study identifies heightened uncertainty as the dominant transmission mechanism for large GPR shocks. Non-linearities activate when substantial geopolitical events trigger precautionary behaviors among households and firms, leading to sharp declines in equity prices and consumption through wealth effects, as well as wait-and-see attitudes that defer economic decisions. This uncertainty channel becomes highly relevant only for substantially large shocks while remaining generally muted with smaller shocks, explaining why asymmetries in magnitude occur with large geopolitical shocks.
- Decomposition of acts versus threats
A crucial innovation involves decomposing GPR into “Acts” and “Threats” components to understand the muted overall price effects. GPR Acts shocks (realized events) function as first-moment negative demand shocks that decrease oil prices, CPI, and inflation expectations while exhibiting limited non-linearities. These reflect dampened aggregate demand and are conceptually closer to traditional negative demand shocks. Conversely, GPR Threats shocks (anticipated disruptions) operate as second-moment uncertainty shocks that increase oil prices and inflation expectations significantly while displaying pronounced non-linearities as shock magnitude increases. These drive speculative oil demand and precautionary pricing behavior, with effects becoming particularly marked in oil prices and inflation expectations for larger shocks.
Geopolitical risk shocks: when size matters
Authors: Davide Brignone, Luca Gambetti, Martino Ricci
From: ECB
