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With war breaking out on the eastern frontier, inflation rising amid a tightening labor market, and supply and demand imbalances creating uncertainty around monetary policy, the economies of Europe, the Middle East, and Africa face profound challenges in their path to postpandemic recovery.

At this year’s virtual Economic Outlook EMEA, held one day before Russia launched its invasion of Ukraine, experts from Chicago Booth and beyond came together to discuss these issues facing the EMEA region. Speakers included Veronica Guerrieri, the Ronald E. Tarrson Professor of Economics and a Willard Graham Faculty Scholar; Randall S. Kroszner, deputy dean for Executive Programs and the Norman R. Bobins Professor of Economics; and José Antonio Álvarez, ’96 (EXP-1), the CEO of Banco Santander, a retail and commercial bank headquartered in Spain. Chris Giles, economics editor for the Financial Times, moderated their conversation on what lies ahead for the EMEA region in 2022.

Ukraine War and Concerns over Growth and Inflation

The final Economic Outlook event took place on the eve of the invasion of Ukraine by Russian troops that followed weeks of uncertainty, which had threatened to weaken consumer and business confidence just as the EMEA region was emerging from the worst of the COVID-19 pandemic.

Guerrieri said she was worried the crisis would deliver a demand shock to the European economy if investment plans were cut and consumer and business confidence tumbled. “If that happens, we are going to see another recession,” she said.

All three panelists predicted that the crisis would likely impact inflation, especially given Europe’s reliance on Russia for 40 percent of its natural-gas supply. Guerrieri said the challenge for the European Central Bank would intensify if Russia decided to retaliate against Western sanctions by stopping or reducing access to natural gas. “That could raise prices and inflation even more, so that could be an added source of concern,” she said.

Álvarez also suggested a hit on consumer confidence would further complicate the ECB’s task. “There is a growing risk that the persistency of geopolitical tensions starts to deteriorate confidence and deteriorate demand little by little,” he said.

Inflation That Keeps Beating Expectations

Inflation is already a worry with the eurozone rate hitting 5.1 percent this past January—the highest since record keeping started in 1997. Álvarez said high inflation combined with low unemployment levels could lead to second-round effects as workers seek higher pay to offset the spike in prices.

“Inflation is not just temporary. It may last for the whole year and may spill over into 2023,” he said. “I do see inflation being persistent, and the ECB will face the challenge of finding the right balance between fostering economic recovery and slowing inflation.”

Kroszner said this was the core question facing policymakers—whether the spike in inflation would be temporary or permanent. While issues such as energy prices and supply chain problems were crucial, the role of market expectations and consumer expectations was also important.

“Most people are not really focused on what the cause of it is. They just know that there’s a lot of inflation,” he said. “Whether it’s in the UK, the US, or much of Europe with super tight labor markets, people are acting in a different way than they have for 20 or 30 years.

“I think we run a risk that the central banks may have to run interest rates up much more than they are forecasting now to try to make sure inflation expectations don’t become unanchored.”

Guerrieri had a more optimistic perspective, explaining that analysis of the eurozone inflation data shows a “big chunk” of the recent spike came from energy prices. “The consensus seems to be that this is going to be something more temporary, rather than persistent,” she said

While the ECB must be responsive to rising inflation and ensure inflation expectations are anchored to the 2 percent target, Guerrieri urged caution given that the spike in prices appeared to be temporary and the economy was still recovering from the shock delivered by the pandemic.

“I think we run a risk that the central banks may have to run interest rates up much more than they are forecasting now to try to make sure inflation expectations don’t become unanchored.”

— Randall S. Kroszner

How Much Has European Fiscal Policy Changed?

While monetary policy is under the microscope, fiscal policy in Europe is also changing—rules on debts and deficits have loosened, and the European Commission has unveiled a €2 trillion investment package.

Guerrieri said politicians now realize the austerity imposed following the European debt crisis was too severe, and that fiscal policy needed to be countercyclical—increasing spending in the face of a downturn, or vice versa. A positive change is that policymakers are using the funds to target specific areas such as digitalization, green transition, and inclusion. “Of course, now maybe defense should be taken into consideration,” she added.

While financial markets have tolerated governments taking on large amounts of debt, Kroszner—who previously served as a governor of the Federal Reserve Board—warned this could change as interest rates continue to rise.

“This is a very important issue when we think more broadly about the Middle East, Africa, and emerging markets generally, about the big differences in the way the markets are treating emerging markets,” he said. “That’s something I don’t think should be ignored, because that has a very important intermediate and long-term consequence.”

‘Optimism Is the Best Prescription’

Given this uncertain outlook, how can investors, people, and companies best react? Kroszner said investors should neither sell off all their assets nor try to time a market recovery in the wake of the current crisis.

“That’s extremely difficult to know—when it’s the right time to respond to geopolitical uncertainties,” he said. “It’s always crucial to try to take a long-run perspective, because things can look very dark in the short run.”

Álvarez struck a positive note when asked about how to move forward amid economic uncertainty. “The best advice is to keep going,” he said, “taking out fear and having confidence in our capacity to overcome whatever problems we are facing. Optimism is the best prescription.”


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