The European Central Bank has published a working paper developing a model that measures how shocks affect the full distribution of macroeconomic outcomes, including recession and stagflation probabilities. Applying a geopolitical shock of the magnitude observed before Russia’s invasion of Ukraine to conditions in December 2025 produces a more contained risk profile in both the euro area and the United States than applying the same shock to January 2022 conditions, with a substantially smaller increase in stagflation risk. The framework combines a regime-dependent mixture vector autoregression with endogenous state probabilities and heteroskedasticity-based shock identification. It captures how shocks alter expected inflation and activity, tail risks and the likelihood of entering high-volatility states. Stagflation is defined as inflation above 2% alongside negative industrial production growth, both measured year over year. The later starting point has a materially lower baseline stagflation risk, while the euro area remains more exposed than the United States to the shock’s combination of weaker activity and elevated inflation. The paper uses monthly euro area and U.S. data through December 2025 and frames the exercise around the risk assessment facing policymakers before the 2026 escalation between the United States and Iran. Its findings are those of the author and do not represent the ECB’s views.
2026-09-25European Central Bank
European Central Bank working paper finds end-2025 conditions reduced stagflation risks from a 2022-scale geopolitical shock
An ECB working paper finds that a geopolitical shock comparable to the one preceding Russia’s invasion of Ukraine would generate substantially less stagflation risk under December 2025 conditions than under January 2022 conditions. Its model measures effects across the full distribution of euro area and U.S. outcomes, including tail risks and transitions into high-volatility states. The findings are those of the author, not the ECB.