The Economics Of Conflict: How War Impacts Money And Interest Rates

The impact of war extends to the intricate web of global economics, where the ripples are felt far and wide

Central banks often respond to geopolitical instability by tightening monetary policy.

Source : Getty

By Akshar Shah 

In a world that seeks peace and prosperity, conflicts and wars remain stark realities. Their far-reaching consequences extend beyond lives lost and cities destroyed. The impact of war extends to the intricate web of global economics, where the ripples are felt far and wide.

War and Macroeconomics

At its core, macroeconomics deals with the study of large-scale economic systems, such as a country or the entire world. The state of the economy—whether it's flourishing or faltering—depends on various factors, one of which is geopolitical stability. When conflicts erupt, their impact on macroeconomics is significant.

1. Disruption of Trade and Supply Chains:

War disrupts trade routes, delays the transport of goods, and leads to shortages. This disruption affects not only the involved regions but also global markets. The globalized world relies on efficient supply chains, and when they are disrupted, prices rise, and macroeconomic stability is challenged.

2. Energy Prices Soar:

Regions often rich in energy resources, such as the Middle East, are frequent hotspots for conflicts. The uncertainty that accompanies war drives up oil prices. This, in turn, has a direct impact on energy costs worldwide, putting upward pressure on inflation rates.

3. Currency Volatility:

During conflicts, investor confidence in the stability of currencies associated with the region in turmoil tends to wane. The result is often currency depreciation, causing fluctuations in exchange rates. These fluctuations affect global trade and cross-border investments, creating further uncertainty in the macroeconomic landscape.

The Impact on Liquidity

Liquidity refers to the ease with which assets can be bought or sold without significantly affecting their prices. In times of geopolitical instability and conflict, liquidity tightens, making it more challenging for individuals, businesses, and governments to access capital. Here's how:

1. Heightened Risk Aversion:

Conflicts make investors more risk-averse. They tend to withdraw investments from riskier assets and seek safer alternatives. This reduction in investment appetite reduces liquidity in riskier assets like stocks and corporate bonds.

2. Reduced Business Activity:

War leads to reduced business activity, as companies put expansion plans on hold and consumers become more cautious. The decrease in business activity results in reduced demand for credit, which, in turn, decreases borrowing and liquidity.

3. Central Bank Response:

War

They may raise interest rates to curb inflationary pressures or stabilise their national currency. While this is a necessary move, it contributes to higher lending rates, making borrowing more expensive for businesses and consumers.

The Impact on Interest Rates

As liquidity tightens, the demand for safe and stable assets increases. One such asset is government bonds. Central banks often respond to increased geopolitical tensions by raising interest rates, as it helps attract capital. This impacts the rates offered by banks on various financial products, including Fixed Deposits (FDs).

In conclusion, conflicts like the Israel-Hamas war shed light on the intricate relationship between war, macroeconomics, liquidity, and interest rates. The interconnectedness of these factors underscores the need for governments, financial institutions, and individuals to adapt to these shifting dynamics.

Understanding this relationship empowers individuals and businesses to make informed financial decisions during turbulent times. As we navigate the complexities of a world marked by geopolitical instability, knowledge becomes not only a source of power but also a tool for resilience in the face of uncertainty.

The writer is the founder and CEO of Fixed Invest.

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