M-RCBG Faculty Working Paper No. 2012-05

Economic Shocks and Their Implications for International Politics

Jeffrey Frankel

March 2012

Abstract

The possible shocks posing the greatest risk for the world economy as of March 2012 include a worsening of the sovereign debt crisis in the Mediterranean members of the euro, contagion to innocent bystanders, a fiscal train-wreck in the United States inflicted by malfunctioning domestic politics, a new oil price shock coming from conflict with Iran, and a hard landing in some emerging markets.   This paper offers a whirlwind tour of historical precedents for these possibilities and other shocks as well:  (1) financial crises (including  sudden stops in the flow of capital to emerging markets,  banking/real estate/equity crashes, and sovereign debt crises); (2) episodes currency instability, (3) recessions, and (4) commodity shocks (including sudden increases in oil or food prices).   Political causes and effects of the economic shocks are considered and the connections with longer term trends such as the rise and fall of powers.  Getting domestic policies right can often do more for a country’s international standing than the application of military power.   This includes loyalty to one’s own ideals, responsible fiscal policy, anticipation of possible shocks, and competent responses to new developments.  The record so far this century is not good.

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