Geopolitical events have become a major source of economic and financial market uncertainty all over the world. Geopolitical risk is defined by Caldara and Iacoviello (2022) as the “threat, realization, and escalation of adverse events associated with wars, terrorism, and any tensions among states and political actors that affect the peaceful course of international relations”. Sudden increases in geopolitical risk are non-economic at their origin, but have important repercussions for macroeconomic and financial variables. In particular, they act as adverse supply shocks by lowering output, raising prices, and increasing financial volatility. Previous literature has measured geopolitical risk as an index reflecting the share of words associated with war or terrorism that appeared in articles of selected English-language newspapers during a given period.
In a recent paper (Bondarenko et al. 2023), we investigate how local conditions and news reporting affect the perception of geopolitical risk. First, the degree of a nation’s involvement or stake in a specific conflict determines how a country is affected by geopolitical events (Mogliani et al. 2022, Sehn et al. 2022, Diakonova et al. 2023). Second, to the instigator of a particular adverse geopolitical event, the possible imposition of sanctions may influence how geopolitical actions are perceived and thus transmitted to the economy. Third, the way geopolitical risk is interpreted by local media depends on the degree of press freedom in a particular country. The selection of events, and the way they are covered in the news, affects the perception of this risk (e.g. Simonov and Rao 2022).
Geopolitical risk cannot be captured in a universal way
Following the method of Caldara and Iacoviello (2022), we construct new monthly geopolitical risk indexes based on Russian-language news sources. Two exercises are of particular interest. First, we compare our country-specific geopolitical risk index to one based on a word count using English-speaking newspapers. Second, we construct a text-based sanctions index for Russia and isolate the sanctions channel in the transmission of geopolitical risk shocks to the Russian economy.
For comparison, we construct a monthly geopolitical risk measure that is based on news sources from the US, UK, and Canada, as proposed by Caldara and Iacoviello (2022), which we call the Anglosphere Geopolitical Risk (GPR) measure. Figure 1 shows our local Russian geopolitical risk index together with the Anglosphere GPR index from June 2002 to December 2022.
Figure 1 Geopolitical risk: Russian versus Anglosphere perspective
The two series have rather different dynamics. For instance, the spike in the local Russian GPR series pertaining to the Russo-Georgian War in 2008 clearly stands out from the rest of the series. Also, the Euromaidan followed by the Russo-Ukrainian War in 2014 is visible as an upward level shift in the local Russian GPR index. In contrast, the Anglosphere GPR series, excluding the large spike at the time of the Iraq War and up to the end of 2021, has much smaller spikes. Furthermore, the Anglosphere GPR does not remain elevated after the annexation of Crimea, pointing to a unique persistent increase of geopolitical risk from a Russian perspective.
Figure 2 Effects of geopolitical risk shocks on the Russian economy
Note: The figure shows impulse responses (IRFs), in per cent, of the Russian economy to a positive one-standard-deviation geopolitical risk shock. In red: IRFs to a shock in the local Russian GPR measure. In blue: IRFs to a shock in the Anglosphere GPR measure. Shaded areas reflect the 68% highest density regions. GPR = geopolitical risk indicator, IR = policy interest rate.
Only locally measured geopolitical risk shocks affect the Russian economy
To gauge the impact of geopolitical risk shocks in Russia, we carry out a Bayesian vector autoregression (VAR) analysis using data from 2002M7 until 2021M12. As Figure 2 shows, a rise in the local Russian geopolitical risk measure has strong adverse effects on the local economy (impulse responses in red). On impact, the Russian GPR index rises by about 12% and remains significantly above zero for one year after the shock. The local geopolitical risk shock resembles a negative supply shock: output drops strongly, and prices rise. The inflationary impact prompts the central bank to raise its policy rate. When we replace the local GPR index with the Anglosphere GPR index and re-estimate the VAR model, we observe only a weak direct impact on the Russian economy (impulse responses in blue).
We also build two separate GPR indexes for Russia, differentiating between independent and state-controlled newspapers. This is to gauge the impact of press freedom on geopolitical risk perceptions. Shocks to our geopolitical risk indicator based on state-controlled news media have somewhat larger effects than do shocks to the indicator constructed using independent media.
Geopolitical risk and sanctions
Geopolitical threats or acts often lead to the imposition of economic sanctions, which restrict or prohibit specific economic activities within the target country. Sanctions are likely to play an important role in the transmission of geopolitical risk. For instance, Ongena et al. (2022) and Simola (2022) predict a deep recession as a result of the 2022 sanctions on Russia. Laudati and Pesaran (2023) construct a news-based index that measures the intensity of sanctions in Iran. Their study is based on news sources from the US and the UK. We build upon their work and develop a sanctions intensity index for Russia, however, using local news sources.
Figure 3 Geopolitical risk indicator and sanctions intensity indicator for Russia
Figure 3 shows that the sanctions index was mostly very low until 2014. However, there were some small spikes around geopolitical events, such as the Russo-Georgian war. Even though no sanctions were imposed on Russia during this time period, potential sanctions against Russia were discussed in the media, and in this sense, affected firms, households, and the government. In response to the beginning of the Russo-Ukrainian war in 2014, Western countries imposed sanctions on Russia. Our index captures these events with a large spike and a level shift. Although the level of the sanctions index fell slowly over time in the following years, our indicator remained at an elevated level. This indicates the long-lasting impact of sanctions that result from direct and indirect effects. A second large spike can be observed in response to the beginning of the attempted full-scale invasion of Ukraine. Although the spike was initially much larger than in 2014, the sanctions index is now close to the value around 2015. In contrast to this, the geopolitical risk indicator remains very elevated at the end of 2022. More generally, an inspection of the two indices highlights that geopolitical actions coincide with increased sanctions.
Figure 4 Geopolitical risk and the sanctions channel in Russia: a counterfactual experiment
Note: The figure shows impulse responses (IRFs), in per cent, of the Russian economy to a positive one-standard-deviation geopolitical risk shock. In red: IRFs, including the sanctions channel. In blue: IRFs excluding the sanctions channel. Shaded areas reflect the 68% highest density regions. GPR = geopolitical risk indicator, IR = policy interest rate.
Recessionary effects of geopolitical risk not driven by sanctions
In a counterfactual exercise, we include the sanctions index in our VAR estimation and then shut it down ex-post to isolate its effect. Our results, shown in Figure 4, suggest that the sanctions channel is important for the transmission of geopolitical risk shocks in Russia. Its main effect is to exacerbate the inflationary consequences of a geopolitical risk shock, necessitating a strong monetary policy tightening by the Russian central bank (see impulse responses in red). At the same time, our findings highlight that local geopolitical risk shocks are important beyond the sanctions channel, as the fall in GDP is substantial even in the exercise where sanctions are absent (see impulse responses in blue).
We construct new local news-based measures of geopolitical risk and study the transmission of geopolitical risk shocks to the Russian economy. Our results highlight that geopolitical risk perceptions matter. Additionally, we develop a sanctions intensity index for Russia and point out that the recessionary effects of geopolitical risk shocks operate beyond the sanctions channels.
Authors’ note: The views expressed here do not necessarily reflect the opinion of the Deutsche Bundesbank or the Eurosystem. Both our geopolitical risk indexes and our sanctions index are publicly available.
Bondarenko, Y, V Lewis, M Rottner and Y Schüler (2023), “Geopolitical Risk Perceptions”, CEPR Discussion Paper No. 18123.
Caldara, D and M Iacoviello (2022), “Measuring geopolitical risk”, American Economic Review 112: 1194–1225.
Diakonova, M, C Ghirelli, L Molina Sanchez and J Pérez (2023), “How Russia’s long history of conflict and other shocks affects its economic growth”, VoxEU.org, 11 April.
Laudati, D and M H Pesaran (2023), “Identifying the effects of sanctions on the Iranian economy using newspaper coverage”, Journal of Applied Econometrics 38 (3): 271–294.
Mogliani, M, J-G Sahuc and L Ferrara (2022), “High-frequency macroeconomic risk measures in the wake of the war in Ukraine”, VoxEU.org, 7 April.
Ongena, S, A Pestova and M Mamonov (2022), “The price of war: Macroeconomic effects of the 2022 sanctions on Russia”, VoxEU.org, 15 April.
Sehn, V, A Meier, G Müller and J Federle (2022), “Economic spillovers from the war in Ukraine: The proximity penalty”, VoxEU.org, 18 April.
Simola, H (2022), “War and sanctions: Effects on the Russian economy”, VoxEU.org, 15 December.
Simonov, A and J Rao (2022), “Demand for Online News under Government Control: Evidence from Russia”, Journal of Political Economy 130: 259–309.