Transmission Channels of Geopolitical Risk – Bank Underground

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Samuel Smith and Marco Pinchetti

Recent events in the Middle East, as well as Russia’s invasion of Ukraine, have sparked renewed interest in the consequences of geopolitical tensions for global economic growth. In this post, we argue that geopolitical risk (GPR) may propagate through two distinct and intrinsically different channels: (i) a deflationary macro channel, and (ii) an inflationary energy channel. . We then use the Bayesian vector autoregression (BVAR) framework to empirically evaluate these channels. Our estimates suggest that GPR shocks may exert downward or upward pressure on advanced economy price levels, depending on which of the two channels the shock propagates through.

GPR channels

To assess the effects of geopolitical tensions on the broader economy, it is first necessary to measure the GPR quantitatively. Our approach to measuring GPR follows the work of Fed researchers Caldara and Iacoviello (2022), who develop an index GPR based on the number of articles covering adverse geopolitical events in major newspapers. This index reflects automated text-search results of the electronic archives of 10 major Western newspapers. It is calculated by counting the number of articles related to adverse geopolitical events (as a share of the total number of news articles) in each newspaper for each month.

Chart 1 shows the behavior of the GPR index from 1990 to 2023. The index is relatively flat during large parts of the sample, and spikes around major episodes of geopolitical tension, such as the outbreak of the Gulf War, 9/11, the invasion of Iraq in the early 2000s, and the Russian invasion of Ukraine in 2022.

Chart 1: GPR Index

Source: Caldara and Iacoviello (2022),

In the same newspaper, Caldara and Iacoviello (2022) show that, on average, increases in the GPR index are associated with less economic activity, arguing that these effects are linked to a variety of macro channels, ranging from human and physical capital destruction to higher military spending and increased precautionary behavior.

However, episodes of geopolitical tension often involve increased concerns about the supply of energy to global markets. Chart 2 shows the cumulative percentage change over the coming three months of West Texas Intermediate (WTI) futures around major geopolitical events. Most of these episodes were followed by increases in oil futures prices, potentially reflecting expectations of supply cutbacks or disruptions in energy flows due to energy production.

Chart 2: WTI futures three-month forward prices during the 30 days following major recent geopolitical events (associated with tensions on energy markets)

Source: Refinitiv Eikon.

This suggests that GPR may also transmit through an additional energy channel, with an effect similar to that of an adverse supply shock. Whether the shock propagates through this channel, and how strong it is relative to the macro channel, will depend on the broader context and/or location of the events associated with the shock. Therefore, it is important to disentangle the two effects to accurately assess the economic consequences of GPR shocks.

Measuring geopolitical surprise

We begin our analysis by constructing a series of exogenous surprises in (i) GPR, and (ii) oil prices that can be assumed to be driven entirely by geopolitical events to a reasonable level of estimation.

To build our surprise series, we draw on a selection of 43 major GPR events from 1986 to 2020. Caldara and Iacoviello (2022), which we update to include four significant events that have occurred over the past three years: the escalation of the Afghanistan crisis in August 2021; Russian invasion of Ukraine in February 2022; Istanbul bombings in November 2022; And events in the Middle East in October 2023.

We calculate the GPR surprise as the daily log difference in the GPR index around these events. To account for oil price surprises, we calculate the daily log difference in WTI future prices from one to six months ahead around the same date. We then take the first of these principal components to capture energy price fluctuations induced by geopolitical shocks.

Disentangling the macro and energy supply components of the geopolitical surprise

We then use our event-study data set in a Bayesian-VAR setting for the euro area, the UK and the US from January 1990 to October 2023 to separate the effects of the macro uncertainty channel from the energy supply channel of the GPR. We adopt the two-block VAR structure proposed by Jarosinski and Karadi (2020)Which uses high frequency data combined with narrative and signal constraints to identify tremors.

Within the high-frequency block, we include our surprise series of the first principal component extracted from (i) the log change in the GPR index on the days of the main geopolitical event, and (ii) the changes in WTI futures from one to six months ahead. We do. Both major geopolitical event days are aggregated at a monthly frequency in case multiple events occur in a month. Within this block, we place signal restrictions at the core of our detection strategy, which we outline in Table A.

We believe that the reaction associated with the macro channel amplifies the upward surprise in the GPR index and the negative surprise in the oil futures curve during the first day of the news, as oil prices fall following a contraction in economic activity. Conversely, we find that the reaction associated with the energy supply channel increases the upward surprise in the GPR index, as well as the positive surprise in the oil futures curve during the first day of the news, because of expectations about future supply. Precautionary oil demand increases in response to concerns. Outages or disruptions in shipping.

Table A, Signal restrictions associated with each channel of GPR

gpr macro GPR Energy
gpr wonder , ,
wti surprise , ,

In our monthly frequency block, we include log GPR indices, log real Brent crude spot prices, log log real natural gas spot prices (as measured by IMF benchmarks), and monetary-policy relevant price index levels. . deviation from their long-term trends, as is standard in the VAR literature).

Identifying two different channels of GPR

Chart 3 shows the response to a geopolitical shock that causes the GPR index to increase by 100 basis points. The first row reports the responses of oil and natural gas prices to an ‘average’ geopolitical shock, which does not separate out macro and energy channel effects along the lines of the work of Caldara and Iacovello. The second and third rows display the responses when we assume that all increases in the GPR index propagate through only the macro channel and only through the energy channel, respectively.

Chart 3: Impulse response functions associated with the ‘average’ 100 basis point GPR shock, as opposed to 100 basis points The shock typically acts through either macro or energy channels.

In the ‘average’ case, the real Brent price rises by about 10% on the location effect, before falling by more than 10% after about six months. However, these dynamics hide two underlying channels. On the one hand, the energy supply channel is associated with a sharp increase in the price of oil by 20%. On the other hand, the macro channel is associated with a sequential decline of more than 20%.

The response of gas prices is more persistent than that of oil prices: the energy channel effect on oil prices is concentrated in the first six months while the effect on gas prices diminishes only during the second year after the shock.

The response of price levels in different sectors follows a pattern that is broadly consistent with energy price dynamics. As Chart 4 shows, inflation falls clearly in the ‘average’ case: the price level in the US falls steadily by about 0.1%, and in the euro area shortly thereafter by about 0.25%, while the response for the UK Not statistically significant. This is consistent with the explanation of the finding Caldara and Iacoviello (2022) Geopolitical shocks, from an empirical perspective, are behaving as contractionary demand shocks.

However, this similarly masks the effects of different underlying channels. On the one hand, the pure macro channel gives rise to a more pronounced decline in the average price level than in the case of ‘average’ GPR shocks, reaching -0.5% and -0.4% in the US and UK. Euro area. On the other hand, the response associated with the energy supply channel is inflationary, with price levels rising steadily by about 0.5% in the US, 0.7% in the UK and 0.6% in the euro area.

Chart 4: Impulse response functions associated with the ‘average’ 100 basis point GPR shock, as opposed to 100 basis points The shock typically acts through either macro or energy channels.


This analysis highlighted the existence of two distinct and intrinsically different transmission channels of the GPR: (i) a deflationary macro channel, and (ii) an inflationary energy supply channel. Policymakers should be aware of these specific channels: GPR shocks can spread in different ways and require different responses.

Samuel Smith works in the Bank’s International Surveillance Division Marco Pinchetti Works in the global analytics division of the bank.

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