Adriana Kugler: Sources of Risk and Inflation

In a companion piece, I laid out why research on uncertainty and inflation has produced such contradictory results: the studies simply do not separate uncertainty by source. Here I want to walk through what happens once you do, because the results are genuinely striking. I have presented this work in academic settings, including a lecture at the London School of Economics on monetary policy under geopolitical shocks.

Take three specific kinds of risk: trade policy uncertainty, geopolitical risk tied to oil, and uncertainty stemming from national security concerns. Analyze these separately instead of folding them into one broad uncertainty variable, and each one carries its own distinct economic signature. Trade policy uncertainty produces the inflationary effect you would expect. Oil-linked geopolitical risk starts out inflationary too, since disruptions to oil supply push energy prices higher, but that effect eventually flips and becomes disinflationary. The third source runs the opposite direction from the start: national security uncertainty initially pushes inflation down, before eventually turning inflationary as military spending rises. Geopolitical risk not connected to oil shows no clear effect either way.

“Trade is acting as a supply shock. Geopolitical risk through oil is acting as a supply shock. National security uncertainty is acting through demand channels.”

What explains the divergence is the channel each source works through. Trade uncertainty and oil-linked geopolitical risk both function as supply shocks; they push up the cost of producing and shipping goods, which raises prices even as it weighs on activity. National security uncertainty works differently, moving through demand rather than supply. Instead of raising production costs, it makes households and businesses more cautious, and that pullback in demand creates downward pressure on inflation. Two of the three sources push prices up through supply, while the third pushes them down through demand, which is exactly why studies that fail to separate these forces end up scattered across the board.

There is an intuitive reason national security uncertainty operates mainly through demand. When the concern is broad and hard to price, the natural response is caution: households postpone big purchases, businesses delay commitments. That is a demand-side reaction, a retreat rather than a cost increase. Yet that same uncertainty, disinflationary at first, can eventually turn inflationary once military spending rises in response. Trade and oil shocks, by contrast, show up first as higher input costs and disrupted supply, which is why they register as inflationary from the start. I have discussed the practical stakes of this in interviews and profiles, including a recent feature on my return to Georgetown.

This framework explains the disagreement running through the existing literature directly. Effects on inflation look positive in some studies and negative in others precisely because those studies do not distinguish among sources. Separate the sources, and the contradictions resolve: supply-side sources push inflation up, the demand-side source pushes it down, and averaging across them produces the muddle that has defined this field for years.

For policymakers, the implication is direct. Facing elevated uncertainty, the first task is not to reach for a general rule about what uncertainty does. It is to ask which specific kind is dominant right now. A trade-driven shock and a security-driven shock call for different responses, precisely because they push inflation in opposite directions. Getting that diagnosis right is the difference between a policy response that stabilizes the economy and one that makes things worse, a distinction that only grows more valuable as trade relationships, energy markets, and security concerns all stay elevated at once.

Adriana Kugler, Ph.D., Labor Economist & Georgetown Professor