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U.S. inflation slowed in May, supporting the case for Federal Reserve officials to pause their run of interest-rate hikes this week.

Both the consumer price index and the core CPI — which excludes food and energy — decelerated on an annual basis, highlighting inflation’s descent since peaking last year. At 4%, year-over-year inflation is now at its lowest level since March 2021, according to data out Tuesday from the Bureau of Labor Statistics.

American Express (NYSE: AXP) today released its first Small Business Financial Confidence Report, highlighting survey data from 550 U.S. small businesses ranging from fewer than 10 to 500 employees. This ongoing report will explore how economic obstacles and market trends influence small business owners’ financial decisions and confidence.

“This new research reveals that among those surveyed, approximately half of the small business owners feel confident when making financial growth decisions, suggesting there’s considerable opportunity for improvement,” said Anna Marrs, Group President of Global Commercial Services and Credit & Fraud Risk at American Express. “By tracking the financial confidence level of small business owners, this report will help uncover the trends we’re seeing behind key money-making decisions businesses owners must make, how the macroenvironment may impact those decisions, and what can help boost their confidence.”

(Moody’s Analytics, “Divergent Data On U.S. Economic Growth,” pg online @ https://www.moodysanalytics.com/-/media/article/2023/weekly-market-outlook-divergent-data-on-us-economic-growth.pdf //um-ef)

The U.S. economic calendar is packed. The highlights will come Tuesday and Wednesday with the release of consumer price index data for May followed by the June meeting of the Federal Open Market Committee. We expect that inflation will continue to moderate, slowly, and the Federal Reserve will take this opportunity to pause interest rate hikes for the first time since the tightening cycle began. The NY Empire State manufacturing survey and the Philly Fed survey will provide a first look at factory performance in June, and we expect a continuation of the weakness that has plagued the industry this year. Jobless claims will remain in focus as they provide labor market insight with the shortest lag time. Initial claims jumped back above 260,000 last week after falling in recent reports. While still short of the breakeven level—which we currently estimate to be around 265,000—it will be important to note any sustained increase in the level of claims, which would likely signal a deceleration in monthly job gains. Other key data will include the NFIB small business survey, producer price index, retail sales, industrial production, and the University of Michigan consumer sentiment survey.

WASHINGTON, June 26 (Reuters) - Big U.S. lenders are expected to show they have ample capital to weather any fresh turmoil in the banking sector during this week's Federal Reserve health checks, although resulting investor payouts are likely to dip slightly, analysts said.

The central bank on Wednesday will release the results of its bank "stress tests" which assess how much capital banks would need to withstand a severe economic downturn.

June 5 (Reuters) - Regional bank executives buying shares in their own companies hit a three-year high in the United States during the second quarter of 2023 as they rushed to restore investor confidence in their firms following the collapse of Silicon Valley Bank.

Such a buying frenzy was last witnessed in the first quarter of 2020, when stocks sold off in reaction to the spread of COVID-19, according to investment research firm VerityData.

The banking crisis that unfolded earlier this year isn't over, and banks could be hit with losses akin to what was seen in 2008 if the Federal Reserve doesn't get inflation under control, according to Bank for International Settlements.

In its annual report published Sunday, the so-called bank for central banks pointed to the lasting ramifications of 2023's bank failures, starting with the collapse of Silicon Valley Bank in early March. SVB's implosion, sparked by losses on its bond holdings as interest rates rose and the value of its fixed income securities plummeted, snowballed into a wider regional bank crisis that resulted in the fall of Signature Bank and First Republic Bank.

The widely predicted U.S. recession remains out of sight as the first half of 2023 winds down, but the consumer sector that has fueled a remarkable recovery from the pandemic shutdowns may finally be showing signs of fraying.

The signals that economists lean on to gauge the odds of a recession are contradictory at the moment. The yield curve remains deeply inverted, and manufacturing surveys have been flashing recession signals for months. But layoffs concentrated in the tech sector have not spread widely so far, and there are pockets of consumer strength, such as travel, that look like a downright boom.

WASHINGTON, May 25 (Reuters) - The number of Americans filing new claims for unemployment benefits rose moderately last week and the prior week's data was revised sharply lower, suggesting persistent labor market strength.

Initial claims for state unemployment benefits increased 4,000 to a seasonally adjusted 229,000 for the week ended May 20, the Labor Department said on Thursday. Data for the prior week was revised to show 17,000 fewer applications received than previously reported. Economists polled by Reuters had forecast 245,000 claims for the latest week.

Macroeconomic activity and economic confidence seem closely linked. Figure 1 shows the relationship between the cyclical component of GDP and a popular measure of economic confidence, the University of Michigan Consumer Sentiment Index. There has not been a single instance of a recession during this period that has not been preceded-accompanied by a significant deterioration in confidence.

The popular press and economic commentators often invoke this relationship when reporting on macroeconomic developments. For example, they attribute recessions to declines in aggregate demand that are triggered by sagging confidence. They link reductions in hiring and investment by firms to their pessimism about the demand for their products; and reduced spending by consumers to their pessimism about their job and income prospects. Consumers' and business' confidence indexes move together, indicating that the pessimism of one class of agents often appears to justify, if not feed, that of other.

Higher interest rates took a toll on the U.S. economy in early 2023, but free-spending consumers are keeping a recession at bay, at least for now.

Gross domestic product, adjusted for inflation, rose at a 1.1 percent annual rate in the first quarter, the Commerce Department said on Thursday. That was down from a 2.6 percent rate in the last three months of 2022 but nonetheless represented a third straight quarter of growth after output contracted in the first half of last year.

In particular, while there are signs the economy has slowed, the labor market still remains extremely tight by historical standards and the 

Some economists are now backing off their predictions of an imminent recession, the common result of a Fed tightening cycle and diminished economic growth. But there remain headwinds, notably less availability of credit and inflation that is eating into consumer pocketbooks.

One of the remarkable things about the global economic order since World War II has been the flexibility of governments in responding to serious crises. From stagflation and the collapse of the Bretton Woods currency regime in the 1970s to the Asian financial crisis of the 1990s to the global financial crisis in this century, the world’s major economies have proven surprisingly adept at finding ways to cooperate to address serious challenges.

This time around, that lucky streak may finally break. The current concatenation of problems—the Russia-Ukraine war, inflation, global food and energy shortages, unwinding asset bubbles in the United States, debt crises in developing countries, and the lingering impacts of COVID-19-related shutdowns and supply chain bottlenecks—may be the most serious crisis of them all, not least because central banks can’t print wheat and gasoline. Yet there are few signs of the collective responses that will be needed to meet these challenges. Global cooperation has never been more urgent—and seemed less likely.

In a broader sense, it is unlikely that even ecological concerns can be addressed by degrowth as illustrated in Fig. 1. First, the environmental issues would be less important during the economic implosion, which could delay the development of sustainable alternative energy. Second, while the environmental picture could temporarily improve during the economic implosion, the carrying capacity will eventually be exceeded yet again as the economic growth resumes, as we illustrate in Fig. 2. Third, given that crude oil is an investable asset, it is likely that the price of crude oil would correct during the implosion due to deleveraging, deflation, and the decrease in demand for energy, which are likely to be only temporarily positive for ecological concerns. However, the temporary lower crude oil prices would also put climate change issues on the backburner, and thus, limit the interest in development of alternative energy projects. Thus, in the long run, the economic implosion would be a net negative for ecological concerns. As soon as the economy rebounds, energy consumption growth would resume and eventually exceed the carrying capacity, this time perhaps even more damaging for the environment due to the significantly delayed development of effective alternative energy sources.

Broadly shared economic prosperity is a bedrock of America’s economic and political strength—both domestically and in the international arena. A strong and equitable recovery from the economic crisis created by COVID-19 would be a powerful testament to the resilience of the American system and its ability to create prosperity at a time of seismic change and persistent global crisis. Such a recovery could attack the profound economic inequities that have developed over the past several decades. Without bold action to help all workers access good jobs as the economy returns, the United States risks undermining the legitimacy of its institutions and its international standing. The outcome will be a key determinant of America’s national security for years to come. An equitable recovery requires a national commitment to help all workers obtain good jobs—particularly the two-thirds of adults without a bachelor’s degree and people of color who have been most affected by the crisis and were denied opportunity before it. As the nation engages in a historic debate about how to accelerate economic recovery, ambitious public investment is necessary to put Americans back to work with dignity and opportunity. We need an intentional effort to make sure that the jobs that come back are good jobs with decent wages, benefits, and mobility and to empower workers to access these opportunities in a profoundly changed labor market. To achieve these goals, American policy makers need to establish job growth strategies that address urgent public needs through major programs in green energy, infrastructure, and health. Alongside these job growth strategies, we need to recognize and develop the talents of workers by creating an adult learning system that meets workers’ needs and develops skills for the digital economy. The national security community must lend its support to this cause. And as it does so, it can bring home the lessons from the advances made in these areas in other countries, particularly our European allies, and consider this a realm of international cooperation and international engagement.

Shared Economic Prosperity Is a National Security Asset

For these reasons, the pandemic itself may be conducive to peace. But what about the relationship between broader economic conditions and the likelihood of war? Might a few leaders still convince themselves that provoking a crisis and going to war could still advance either long-term national interests or their own political fortunes? Are the other paths by which a deep and sustained economic downturn might make serious global conflict more likely? One familiar argument is the so-called diversionary (or “scapegoat”) theory of war. It suggests that leaders who are worried about their popularity at home will try to divert attention from their failures by provoking a crisis with a foreign power and maybe even using force against it. Drawing on this logic,  that President Donald Trump will decide to attack a country like Iran or Venezuela in the run-up to the presidential election and especially if he thinks he’s likely to lose. This outcome strikes me as unlikely, even if one ignores the . War is always a gamble, and should things go badly—even a little bit—it would hammer the last nail in the coffin of Trump’s declining fortunes. Moreover, none of the countries Trump might consider going after pose an imminent threat to U.S. security, and even his staunchest supporters may wonder why he is wasting time and money going after Iran or Venezuela at a moment when thousands of Americans are dying preventable deaths at home. Even a successful military action won’t put Americans back to work, create the sort of testing-and-tracing regime that competent governments around the world have been able to implement already, or hasten the development of a vaccine. The same logic is likely to guide the decisions of other world leaders too. Another familiar folk theory is “military Keynesianism.” War generates a lot of economic demand, and it can sometimes lift depressed economies out of the doldrums and back toward prosperity and full employment. The obvious case in point here is World War II, which did help the U.S economy finally escape the quicksand of the Great Depression. Those who are convinced that great powers go to war primarily to keep Big Business (or the arms industry) happy are naturally drawn to this sort of argument, and they might worry that governments looking at bleak economic forecasts will try to restart their economies through some sort of military adventure. I doubt it. It takes a really big war to generate a significant stimulus, and it is hard to imagine any country launching a large-scale war—with all its attendant risks—at a moment when debt levels are already soaring. More importantly, there are lots of easier and more direct ways to stimulate the economy—infrastructure spending, unemployment insurance, even “helicopter payments”—and launching a war has to be one of the least efficient methods available. The threat of war usually spooks investors too, which any politician with their eye on the stock market would be loath to do. Economic downturns can encourage war in some special circumstances, especially when a war would enable a country facing severe hardships to capture something of immediate and significant value. Saddam Hussein’s decision to seize Kuwait in 1990 : The Iraqi economy was in terrible shape after its long war with Iran; unemployment was threatening Saddam’s domestic position; Kuwait’s vast oil riches were a considerable prize; and seizing the lightly armed emirate was exceedingly easy to do. Iraq also owed Kuwait a lot of money, and a hostile takeover by Baghdad would wipe those debts off the books overnight. In this case, Iraq’s parlous economic condition clearly made war more likely. Yet I cannot think of any country in similar circumstances today. Now is hardly the time for Russia to try to grab more of Ukraine—if it even wanted to—or for China to make a play for Taiwan, because the costs of doing so would clearly outweigh the economic benefits. Even conquering an oil-rich country—the sort of greedy acquisitiveness that —doesn’t look attractive when there’s a vast glut on the market. I might be worried if some weak and defenseless country somehow came to possess the entire global stock of a successful coronavirus vaccine, but that scenario is not even remotely possible. If one takes a longer-term perspective, however, a sustained economic depression could make war more likely by strengthening fascist or xenophobic political movements, fueling protectionism and hypernationalism, and making it more difficult for countries to reach mutually acceptable bargains with each other. The history of the 1930s shows where such trends can lead, although the economic effects of the Depression are hardly the only reason world politics took such a deadly turn in the 1930s. Nationalism, xenophobia, and authoritarian rule were making a comeback well before COVID-19 struck, but the economic misery now occurring in every corner of the world could intensify these trends and leave us in a more war-prone condition when fear of the virus has diminished.

There’s nothing like a doomsday prediction to start the week. And don’t worry, Nouriel Roubini has  of them. The economist, professor emeritus at New York University’s Stern School of Business, and CEO of Roubini Macro Associates, has even earned the moniker “Dr. Doom” for his pessimistic forecasts. And on Sunday, Roubini—once again—warned that the global economy is heading for disaster. “I think that really the world is on a slow-motion train wreck,” he . “There are major new threats that did not exist before, and they’re building up and we’re doing very little about it.” Roubini has been sounding the alarm about a coming economic crisis of the ages for over a year now. In his new book, , he breaks down how challenges like climate change, competition between economic superpowers, and rising global debts are all combining to create a nightmare scenario for the world. Roubini even  in November that “another variant of a Great Depression” was possible if policymakers don’t act to stop these “MegaThreats.” “There may be severe financial crises and debt crises,” he warned. And even though the U.S. is in a better place than many nations, according to Roubini, Americans can expect a recession too. “This is not going to be a short and shallow recession, it’s going to be deep and protracted,” he said on Sunday.

A debt crisis and World War III?

Mr Kissinger is reviled by many as a warmonger for his part in the Vietnam war, but he considers the avoidance of conflict between great powers as the focus of his life's work. After witnessing the carnage caused by Nazi Germany and suffering the murder of 13 close relatives in the Holocaust, he became convinced that the only way to prevent ruinous conflict is hard-headed diplomacy, ideally fortified by shared values. "This is the problem that has to be solved," he says. "And I believe I've spent my life trying to deal with it." In his view, the fate of humanity depends on whether America and China can get along. He believes the rapid progress of ai, in particular, leaves them only five-to-ten years to find a way. Mr Kissinger has some opening advice to aspiring leaders: "Identify where you are. Pitilessly." In that spirit, the startingpoint for avoiding war is to analyse China's growing restlessness. Despite a reputation for being conciliatory towards the government in Beijing, he acknowledges that many Chinese thinkers believe America is on a downward slope and that, "therefore, as a result of an historic evolution, they will eventually supplant us." He believes that China's leadership resents Western policymakers' talk of a global rules-based order, when what they really mean is America's rules and America's order. China's rulers are insulted by what they see as the condescending bargain offered by the West, of granting China privileges if it behaves (they surely think the privileges should be theirs by right, as a rising power). Indeed, some in China suspect that America will never treat it as an equal and that it's foolish to imagine it might. However, Mr Kissinger also warns against misinterpreting China's ambitions. In Washington, "They say China wants world domination ...The answer is that they [in China] want to be powerful," he says. "They're not heading for world domination in a Hitlerian sense," he says. "That is not how they think or have ever thought of world order." In Nazi Germany war was inevitable because Adolf Hitler needed it, Mr Kissinger says, but China is different. He has met many Chinese leaders, starting with Mao Zedong. He did not doubt their ideological commitment, but this has always been welded onto a keen sense of their country's interests and capabilities. Mr Kissinger sees the Chinese system as more Confucian than Marxist. That teaches Chinese leaders to attain the maximum strength of which their country is capable and to seek to be respected for their accomplishments. Chinese leaders want to be recognised as the international system's final judges of their own interests. "If they achieved superiority that can genuinely be used, would they drive it to the point of imposing Chinese culture?" he asks. "I don't know. My instinct is No... [But] I believe it is in our capacity to prevent that situation from arising by a combination of diplomacy and force." One natural American response to the challenge of China's ambition is to probe it, as a way to identify how to sustain the equilibrium between the two powers. Another is to establish a permanent dialogue between China and America. China "is trying to play a global role. We have to assess at each point if the conceptions of a strategic role are compatible." If they are not, then the question of force will arise. "Is it possible for China and the United States to coexist without the threat of all-out war with each other? I thought and still think that it [is]." But he acknowledges success is not guaranteed. "It may fail," he says. "And therefore, we have to be militarily strong enough to sustain the failure." The urgent test is how China and America behave over Taiwan. Mr Kissinger recalls how, on Richard Nixon's first visit to China in 1972, only Mao had the authority to negotiate over the island. "Whenever Nixon raised a concrete subject, Mao said, 'I'm a philosopher. I don't deal with these subjects. Let Zhou [Enlai] and Kissinger discuss this.'...But when it came to Taiwan, he was very explicit. He said, 'They are a bunch of counter-revolutionaries. We don't need them now. We can wait 100 years. Someday we will ask for them. But it's a long distance away.'" Mr Kissinger believes that the understanding forged between Nixon and Mao was overturned after only 50 of those 100 years by Donald Trump. He wanted to inflate his tough image by wringing concessions out of China over trade. In policy the Biden administration has followed Mr Trump's lead, but with liberal rhetoric. Mr Kissinger would not have chosen this path with respect to Taiwan, because a Ukrainian-style war there would destroy the island and devastate the world economy. War could also set back China domestically, and its leaders' greatest fear remains upheaval at home.

The fear of war creates grounds for hope. The trouble is that neither side has much room to make concessions. Every Chinese leader has asserted his country's connection to Taiwan. At the same time, however, "the way things have evolved now, it is not a simple matter for the United States to abandon Taiwan without undermining its position elsewhere." Mr Kissinger's way out of this impasse draws on his experience in office. He would start by lowering the temperature, and then gradually build confidence and a working relationship. Rather than listing all their grievances, the American president would say to his Chinese counterpart, "Mr President, the two greatest dangers to peace right now are us two. In the sense that we have the capacity to destroy humanity." China and America, without formally announcing anything, would aim to practise restraint. Never a fan of policymaking bureaucracies, Mr Kissinger would like to see a small group of advisers, with easy access to each other, working together tacitly. Neither side would fundamentally change its position on Taiwan, but America would take care over how it deploys its forces and try not to feed the suspicion that it supports the island's independence.

The international economic architecture built after 1945 was based on a powerful idea: economic interdependence is crucial, if insufficient, for global peace and prosperity. The International Monetary Fund, the World Bank, and the predecessor to the World Trade Organization were founded in response to the three preceding decades of ceaseless instability, when the world had been devastated by two world wars, the Great Depression, and political extremism. It had also been a period of deglobalization, in which countries retreated into increasingly isolated trading blocs. In the rubble of World War II, governments sought to construct a new system that, by linking countries in a dense web of economic ties, would consign such chaos and division to history.

For much of the past 75 years, policymakers from across the world recognized the power of economic interdependence. Countries tore down trade barriers, opening their economies to one another. On balance, their record was impressive. Closer economic integration went hand in hand with rising global prosperity, an unprecedented reduction in poverty, and an unusually long period of great-power peace. Since 1990, the share of the world’s population living in extreme poverty has fallen by three-quarters. At the center of this great leap in human well-being was a 20-fold increase in international trade volumes, which helped lift per capita incomes by a factor of 27 over the last six decades.

Figure 6 shows the response in terms of the number of conflict events per one million people to a commodity ToT shock in the full sample of Low- and Middle-Income Countries. A deterioration of the commodity ToT, on average, increases the frequency of conflicts. Specifically, we find that a negative ToT shock equivalent to one percent of GDP increases the likelihood of experiencing a conflict by 0.05 events per one million people in the year following the shock. The estimate of 0.05 events per one million people is equivalent to or explains 1.6 percent of the average country’s conflict events per year in our sample. Conflicts remain more likely for 2-3 years after a shock to income before the impact gradually decays. As discussed above, the literature highlights the potential for different directions of the effect of an income shock on conflicts. The opportunity-cost and state-capacity channels predict that a negative income shock increases conflict, whereas the predation effect would work in the opposite way. Previous studies trace the significance of each channel in specific economic sectors. For instance, the predation effect is often reported in oil and other natural resources sectors (e.g., Ross, 2004; Adhvaryu et al., 2021). Dal Bó and Dal Bó (2011) theoretically demonstrate that output price increases in capital-intensive sectors lead to fights over rent through predation, whereas the opportunity cost channel prevails in labor-intensive sectors. Our estimated negative response in the baseline implies that the former two channels should be dominant at the aggregate level. This is consistent with our use of a broad-based commodity ToT index that de-emphasizes idiosyncratic effects in specific sectors. Figure 6: Responses of the Number of Conflict Events to a Commodity ToT Shock, Baseline Specification Notes: The sign of the estimated coefficients is flipped and multiplied by 100. A positive response in the figure indicates an increase in conflict events following a negative commodity ToT shock. Shaded areas indicate the 68 and 90 percentiles of the responses (same below). INTERNATIONAL MONETARY FUND 19 4.2 Evolution of Conflict dyads We further analyze the impact of the commodity ToT shocks on the evolution of underlying conflict dyads. To do so, we decompose conflict dyads, defined as a pair of two opposing actors that are involved in conflict events, into those starting in a given year (“entry”) and those continuing from a past year (“continuation”). We count a dyad as “active” and therefore an “entry” if it causes at least one conflict event in a given year, but was not active in the previous year as a new conflict dyad. We define “continuation” of a conflict dyad if a dyad in a given year was active in the previous year too. Then, we use the number of entry and continuation of dyads as an outcome variable in the regression. The results in Figure 7 illustrate that negative commodity ToT shocks increase the number of continued conflict dyads and prolong existing conflicts in Panel (a). 11 This said, the effect is not strong enough to trigger an entry of a new dyad in Panel (b). The results imply that the increase in the total number of conflict events shown in Figure 6 can be attributed to the intensification of violent activities by existing dyads. It echoes a narrative that conflicts arise from complex contexts, including political, ethnical, and social factors. Economic factors may not be the main driver of a new occurrence of conflict but seem to play an important role in determining the duration of violent activities. Figure 7: Responses of Continuation and Entry of Conflict dyads (a) Continuation (b) Entry 4.3 Countries at Risks Given the statistically significant response of a commodity ToT shock on conflict intensity, a natural next question relates to the type of countries that are most at risk of conflicts when an economic shock hits. To answer this question, we first look at the differences in impact across country groups. Then we examine the relevance of each economic channel. Income level. Previous studies often associate income level with the occurrence of conflicts (e.g., Blattman and Miguel, 2010). However, it is less clear how the impact of a Terms-of-Trade shock differs across countries’ 11 The choice of outcome variables here is closely related to the studies that focus on the onset and duration of conflict of (e.g., Collier and Hoeffler, 2004; Brückner and Ciccone, 2010; Collier et al., 2004; Buhaug et al., 2009). These studies tend to use a binary variable that indicates the onset and presence of conflict at the national level, and thus do not differentiate dyads within countries. INTERNATIONAL MONETARY FUND 20 income levels. To see this point, we modify the regression equation (2) by accommodating differential impacts through interaction terms: 𝑦𝑦𝑖𝑖,𝑡𝑡+𝑠𝑠 − 𝑦𝑦𝑖𝑖,𝑡𝑡−1 = 𝟏𝟏𝑖𝑖,𝑡𝑡,𝑗𝑗 �𝛽𝛽𝑠𝑠,1 Δ𝑡𝑡𝑡𝑡𝑡𝑡𝑖𝑖,𝑡𝑡 + �𝛿𝛿𝑘𝑘𝑘𝑘,1 𝐾𝐾 𝑘𝑘=1 Δ𝑡𝑡𝑡𝑡𝑡𝑡𝑖𝑖,𝑡𝑡−𝑘𝑘� + (1 − 𝟏𝟏𝑖𝑖,𝑡𝑡,𝑗𝑗) �𝛽𝛽𝑠𝑠,0 Δ𝑡𝑡𝑡𝑡𝑡𝑡𝑖𝑖,𝑡𝑡 + �𝛿𝛿𝑘𝑘𝑘𝑘,0 𝐾𝐾 𝑘𝑘=1 Δ𝑡𝑡𝑡𝑡𝑡𝑡𝑖𝑖,𝑡𝑡−𝑘𝑘� +�𝛼𝛼𝑙𝑙𝑙𝑙 𝐿𝐿 𝑙𝑙=1 Δ𝑦𝑦𝑖𝑖,𝑡𝑡−𝑙𝑙 + 𝜇𝜇𝑖𝑖,𝑠𝑠 + 𝜆𝜆𝑡𝑡,𝑠𝑠 + 𝜈𝜈𝑗𝑗,𝑡𝑡,𝑠𝑠 + 𝜀𝜀𝑖𝑖,𝑡𝑡,𝑠𝑠 ⋯ (3) where 𝟏𝟏𝑖𝑖,𝑡𝑡,𝑗𝑗 is an indicator function that takes a value of one for given characteristic 𝑗𝑗 and zero otherwise. The IR of each group is represented by�𝛽𝛽𝑠𝑠,1� and �𝛽𝛽𝑠𝑠,0� for 𝑠𝑠 = 0, 1, 2, …, respectively. We split the sample into LICs and lower MICs (GNI per capita below US$4,045 in 2020) and upper MICs according to the World Bank’s income classification. We complement the classification by using eligibility to the concessional lending resources of the IMF (Poverty Reduction and Growth Trust, PRGT), which is based on an assessment of the level of income per capita, market access, and the severity of short-term vulnerabilities. The lower-income groups include 81 countries according to the World Bank’s income classification and 69 PRGT-eligible countries. The country classification is presented in Annex I. Figure 8 displays quite different patterns across income groups. The responses in LICs/lower-MICs and PRGTeligible countries (red) are considerably larger. The impact peaks at 0.10 conflict events per one million people for both low-income country groups, almost double that for the whole sample shown in Figure 6. The impact can explain 2.5 percent of the average conflict incidents in these country groups, implying that not only the number of countries experiencing conflicts is higher among LICs but also that these countries are more sensitive to economic shocks. Another notable feature is that the impact is highest in the second year after an initial shock and is persistent for more than five years, while the first-year response stays close to that of higher income groups (blue). By contrast, the responses in the higher income groups remain muted over the estimation period. In combination with the number of conflict events shown in Figure 3, this evidence implies that while several upper MICs, for example Mexico, suffer a large number of domestic violent events, the impact of economic shocks is relatively weak compared to that found in LICs. Figure 8: Responses of the Number of Conflict Events, Comparison of Income Groups (a) LICs and lower MICs (b) PRGT-eligible countries Note: Red lines show the IRs of LICs and lower MICs in panel (a) and of PRGT-eligible countries in panel (b). INTERNATIONAL MONETARY FUND 21 FCS. Figure 9 shows the impact of a commodity ToT shock for FCS and non-FCS. As a part of international efforts to support countries suffering conflict, the World Bank releases annually a list of FCS.12 Noting the complexity of fragility and conflict, it relies on two considerations for identifying FCS: (i) countries with high levels of institutional and social fragility, assessed through measures of the quality of policies and institutions, and manifestations of fragility; and (ii) countries affected by violent conflict, identified based on a threshold number of conflict-related deaths relative to the population. The World Bank’s list for 2023 contains 37 economies, most of which are LICs. We use the FCS classification as an alternative country grouping in the heterogeneity regression equation (3). As the list is available only after 2006, we use the 2006 classification for earlier years. As can be expected, our results presented in Figure 9 indicate that FCS display a significantly larger number of conflict events in response to a ToT shock. The initial impact is close to that of LICs shown in Figure 8 and there is no unwinding of the effect even 5 years after the initial shock. In what follows, we look more closely into several dimensions of country characteristics to disentangle potential transmission channels. Figure 9: Responses of the Number of Conflict Events, FCS and non-FCS Note: Red line shows the IRs of FCS. 4.4 Tracking the Transmission Channels What economic channels account for the differential impacts of the commodity ToT shocks on conflict intensity? Indeed, income levels are known to be highly correlated with various country characteristics in the development context. For instance, Blattman and Miguel (2010) emphasize that the aggregate income level serves as an indicator for both the opportunity costs of individuals to participate in conflict activities and state capacity to control conflicts, thus not identifying the channel in effect. Here we use measures of inequality and fiscal space as an indicator of country characteristics, 𝟏𝟏𝑖𝑖,𝑡𝑡,𝑗𝑗, in the regression equation (3) to examine the relevance of the opportunity-cost and state-capacity channels.13 Finding heterogenous effects across inequality levels would support the opportunity cost hypothesis, which states that individuals with limited income sources are more easily involved in violent activities. Analysis of heterogeneity across fiscal space would likewise indicate that the provision of public goods and services is constrained and governments cannot properly manage the economy during periods of adverse shocks. 12 The latest list is found here: https://www.worldbank.org/en/topic/fragilityconflictviolence/brief/harmonized-list-of-fragile-situations 13 We focus on these two channels as they imply increases of conflicts responding to an adverse income shock in line with our empirical result, while setting aside the predation channel which works in the other direction. These channels’ relevance is often highlighted by policy makers (e.g., WB and UN, 2018). INTERNATIONAL MONETARY FUND 22 Inequality. We consider three measures of inequality from the World Bank database: (i) Gini coefficient, (ii) unemployment rate, and (iii) the share of the population exposed to food insecurity. 14 Note that while the unemployment rate is not a direct measure of inequality, a higher unemployment rate implies that more unemployed individuals are vulnerable to recruitment into violent forces as their alternative options are likely to be less profitable than those of employed individuals. We identify countries with higher inequality by splitting the sample along the top 25th percentile of each measure and compare the IRs of the two groups. Each variable is lagged by one period from the shock to isolate its impact. The left side of Figure 10 displays the result. For ease of presentation, the figure shows the peak response of the higher inequality group (red) and that of the other group (blue). The estimated responses are considerably larger in countries that are in the highest quantile in each of three inequality measures, meaning that countries with higher inequality experience more severe violence in response to a deterioration of their ToT. Inequality increases the likelihood of conflicts in a range of 0.10 to 0.15 conflict events per one million people; these effects are even stronger than those for the LICs in the sample. By contrast, the estimates for countries with low levels of inequality are close to zero. These results are consistent with the opportunity cost hypothesis presented by the literature. They are also consistent with the hypothesis of the economics of crime (Becker, 1968) that high inequality increases the benefit of committing a crime or engaging in violent activities. Figure 10: Heterogenous Responses in Inequality and Fiscal Capacities Notes: The responses of the number of conflict events per one million population 1 year after a negative commodity ToT shock. Red markers show the response of country groups with higher inequality or lower fiscal space. Fiscal Capacity. Fiscal policies can mitigate macroeconomic shocks. To assess the effect of fiscal policies as a tool for mitigating the economic fallout from ToT shocks, we identify countries with limited fiscal space using gross external debt and the fiscal balance in percent of GDP from World Bank data and the July 2022 vintage of the IMF’s World Economic Outlook Database, respectively. We use the third quartile cutoff (top 25th 14 The indicator is defined as the percentage of people in the population who live in households classified as moderately or severely food insecure. A household is classified as moderately or severely food insecure when at least one adult in the household has reported to have been exposed, at times during the year, to low quality diets and might have been forced to also reduce the quantity of food they would normally eat because of a lack of money or other resources. INTERNATIONAL MONETARY FUND 23 percentile) to split the sample and compare the IRs in the two country groups, as we do for the inequality measures described above. The hypothesis is that countries with a higher level of external debt or with a higher fiscal deficit are more likely to face fiscal constraints when hit by a negative ToT shock, thereby limiting the government’s ability to organize an effective response to support the economy. The right-hand side of Figure 10 indicates that the estimated impact tends to be larger in countries with relatively low fiscal space. The estimated coefficient is substantially larger for counties with higher external debt, even if the standard error is somewhat large. The result could reflect the fact that most LICs and lower MICs rely on external financial support to implement their budget. In these cases, an elevated level of external debt can become a binding constraint for fiscal policies. Overall, the analysis in this section suggests the presence of both opportunity-cost and state-capacity channels in determining the impact of commodity ToT shocks on conflict. These channels have often been discussed in the literature. Our innovation is that we separately test each of these hypotheses using proxy indicators and find the expected results. This said, we note that these proxies may also capture deep-rooted structural issues. For instance, limited fiscal capacities may be a consequence of intensive conflicts in past years, which may also account for the large standard error in the regression analysis. We conduct further robustness checks in Section V. 4.5 Testing for Spillovers Across Countries Consequences of conflicts can spread to neighboring countries. For instance, Buhaug and Gleditsch (2008) document that the eruption of civil war in the Democratic Republic of Congo (then Zaire) was influenced by events in neighboring countries. With such spillover of conflicts, the overall impact of a macroeconomic shock could be larger than that captured in a single country. We examine this hypothesis by constructing a distanceweighted index of other countries’ commodity ToT: �𝜅𝜅𝑖𝑖′Δ𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡−𝑚𝑚,𝑖𝑖′ 𝑖𝑖′≠𝑖𝑖 where 𝜅𝜅𝑖𝑖′ is the distance between country 𝑖𝑖 and country 𝑖𝑖′, and Δ𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡−𝑚𝑚,𝑖𝑖′ is the commodity ToT change in country 𝑖𝑖′ at time 𝑡𝑡 − 𝑚𝑚. We use the distances from the country of interest to all other country pairs to construct the weights. The distance data are from United States International Trade Commission. We add the one- to two-year lagged terms, i.e., 𝑚𝑚 = 1, 2, to the baseline regression equation (1). The results are presented in Figure 11. The IRs become significant three years after the occurrence of the initial ToT shocks, implying that the spillover effect occurs with some time lag. The literature highlights various potential mechanisms that could drive the spillover of conflicts. First, there could be a direct expansion of violent activities or advancement of armed forces into neighboring countries. Another possible explanation is that information on a country’s conflict can trigger conflict events in other countries by influencing people’s beliefs. Furthermore, refugee flows can weigh on budgets (e.g., through the provision of shelter or healthcare) and weaken their fiscal capacity in host countries. In LICs and MICs, which host 74 percent of refugees, 15 pressure on already stretched government budgets can lead to a deterioration in the provision of public services essential for human capital development, unless humanitarian and development support is scaled up to both meet these needs (Rother et al., 2016; Bohmelt, Bove and Gleditsch, 2018) and enable policies that 15 https://www.unhcr.org/refugee-statistics/ INTERNATIONAL MONETARY FUND 24 raise the economic welfare of the local and displaced communities (IMF, 2022b). In these contexts, support for state capacity is critical (e.g., Salehyan and Gleditsch, 2006). Finally, ToT shocks can generate negative economic spillovers that potentially lead to conflicts in neighboring countries as well. Although our empirical results are agnostic with regard to the precise channels at work, the presence of spillovers implies that economic shocks can have an impact on conflicts that extends beyond the borders of the countries that were hit at first.

Conflict data. We conduct cross-country analysis to examine the impact of a macroeconomic shock on the intensity of conflicts. The main dependent variable in the regression analysis is the intensity of conflict, as measured by the number of conflict events per one million people. Conflict data rely on the Uppsala Conflict Data Program Georeferenced Events Dataset (UCDP GED) (Sundberg and Melander, 2013). It records all individual conflict events that are defined as organized violence. Conflict events are incidences of the use of armed force by an organized actor against another organized actor, or against civilians that result in at least one direct death. We use the total number of conflict events, including state-based conflicts in which incidents take place between two parties and at least one is the government of a state; non-state-based conflicts between two parties neither of which is the government of a state; and one-sided conflicts in which armed force is used by the government of a state or by a formally organized group against civilians. 6 By contrast, the data does not include non-organized or non-violent incidences, such as protests, riots, and violence by civilians. The UCDP GED contains events for all dyads7 and actors that have surpassed the 25 deaths threshold at least in 6 We find that each type of conflict events displays similar responses to a commodity ToT shock. 7 A dyad is defined in the UCDP GED as a pair of two opposing actors. In a state-based conflict, a dyad is composed of two actors, at least one of which is a government. A dyad in non-state conflict involves two organized armed actors, neither of which is a government. In one-sided conflicts, UCDP does not consider opposing actors a dyad, but rather an armed actor attacking the civilian population. INTERNATIONAL MONETARY FUND 11 one calendar year. The information is based on global news reports found using search strings run through the Dow Jones Factiva aggregator. The data cover the period from 1989 to 2021. Our dataset contains 133 countries, excluding high-income countries according to the World Bank’s GNI per capita classification (above USD 12,535 in 2020). The list of countries is presented in Annex I. We aggregate the number of conflict events by country and year. We remove the top one percentile of observations of each variable as outliers, on the premise that extremely intensive conflict episodes (e.g., Rwanda in the 1990s) are likely not driven by economic channels applicable to most countries. We normalize the number of conflict events per one million people in the population to account for country size. Mueller (2016) and Novta and Pugacheva (2021) highlight that per-capita measures are arguably most relevant from a macroeconomic perspective, as absolute numbers skew the sample toward large countries. This is particularly relevant for our analysis as countries with relatively small populations often suffer intensive conflict. 8 We complement the analysis by using the number of fatalities per one million people caused by conflicts as an alternative dependent variable measuring the intensity of conflict, obtaining similar results. Furthermore, to better understand how macroeconomic shocks affect different stages of conflict formation, we investigate entry and continuation of conflict dyads. Details are presented in Section IV. Figure 3 displays a snapshot of the global landscape of conflict events for 2021. Conflict events were mostly concentrated in Sub-Saharan Africa, the Middle East and Central and Latin America, with the highest intensity of conflicts occurring in Afghanistan. Mexico, Syria, Yemen, Somalia, the Central African Republic, Cameroon and Mali all recorded more than 50 conflict events per one million inhabitants. Figure 3: Number of Conflict Events per one Million Inhabitants, 2021 Source: UCDP GED. Commodity terms-of-trade. A key identification challenge for exploring the impact of macroeconomic shocks on conflicts is to control for endogeneity since there is ample empirical evidence in the literature (see Section II) showing that macroeconomic conditions are affected by violence. To overcome this endogeneity concern, we 8 Novta and Pugacheva (2021) report that per-capita conflict measures have significant effects on macroeconomic variables whereas absolute figures do not. Likewise, we find that the absolute number of conflict cases increase, but not significantly, in response to a negative commodity ToT shock. INTERNATIONAL MONETARY FUND 12 resort to an exogenous variation of income using the country specific commodity terms-of-trade (ToT) index, constructed by Gruss and Kebhaj (2019) and maintained by the IMF Research Department.9 The commodity ToT index covers 182 economies and provides estimates for the gains and losses in income associated with changes in international commodity prices. Specifically, the index uses 45 world commodity prices from the IMF Primary Commodity Price database classifiable under the following four categories: 1. Energy: coal, crude oil, and natural gas. 2. Metals: aluminum, copper, gold, iron ore, lead, nickel, tin, uranium, and zinc. 3. Food and beverages: bananas, barley, beef, cocoa, coffee, corn, fish, fish meal, groundnuts, lamb, olive oil, oranges, palm oil, poultry, rapeseed oil, rice, shrimp, soybean meal, soybean oil, soybeans, sugar, sunflower seed oil, swine meat, tea, and wheat. 4. Agricultural raw materials: cotton, hard logs, hard sawnwood, hides, natural rubber, soft logs, soft sawnwood, and wool. For every country in our sample, each commodity price in the index is weighed by its share in total net exports scaled to GDP to proxy its impact on aggregate income. Using net exports ensures that the effect of price changes for both exports and imports on GDP are accounted for: a one percentage point change in the index represents the equivalent percentage point change in GDP expected for each country due to net commodity price changes. The country-commodity level trade data is sourced from the United Nations Comtrade Database. The shares are built with three-year rolling averages for trade values, so that the index tracks changes in a country’s industrial structure over time. Since the weights are lagged, changes in the index should reflect changes in international prices rather than possibly endogenous responses in trade volumes. It is worth noting that the commodity ToT index is different from a standard ToT measure as it accounts for the share of each export and import good in a country’s economic structure. Gruss and Kebhaj (2019) compare the impact of the commodity ToT index and a standard ToT on macroeconomic variables and report that only the former influences macroeconomic aggregates in a statistically significant way. Figure 4 presents the commodity ToT index for the sample countries with the highest gains and losses from commodity price changes in 2021. The figure shows that there is significant variation in ToT changes within and across regions. For example, within the Middle East and North Africa region, oil-exporting countries like Qatar, Kuwait and Libya experienced a positive change in their terms of trade, while other countries such as Jordan and Djibouti suffered significant losses. It is also worth noting that the changes in the index vary considerably even across oil exporting countries due to their different net export shares relative to GDP and the impact of price changes for other commodities. 9 The latest data is available at: https://data.imf.org/?sk=2CDDCCB8-0B59-43E9-B6A0-59210D5605D2. INTERNATIONAL MONETARY FUND 13 Figure 4: Commodity Terms of Trade in Selected Countries, 2021 (year-on-year change, percent) Other economic and political variables. Our study relies on a variety of economic and political indicators used as alternative dependent measures, control variables, and, importantly, to investigate the significance of macroeconomic effects in a variety of contexts. Missing values are imputed using the previous or subsequent year’s observations to maintain sample size. Details on each variable are presented in the respective section. A full table of variables and sources can be found in Annex II. Descriptive statistics. Table 1 reports summary statistics for our dependent conflict variables, independent variables, and some economic characteristics that we explore in the results section. Between 1989 and 2021, there are 4,412 observations for 133 countries. The average number of conflict events per year per country in our sample is 3.19 per one million people, with 51.7 resulting fatalities per one million people. 10 Notably, conflict intensity differs significantly by a country’s income level. Low-Income Countries and Lower Middle-Income Countries (GDP per capita below US$4,045 in 2020) experienced an average 3.98 conflict events per one million people, resulting in 75.06 fatalities per one million people. This compares to 1.95 conflict events and 14.83 fatalities, respectively, for Upper Middle-Income Countries. Entry and continuation of conflict dyads are also higher for Low-Income and Lower Middle-Income Countries. The table also includes summary statistics for the commodity ToT index, the independent variable for this study. The index is normalized to 100 in 2012 and fluctuates between a loss of about 10 percent of GDP and a gain of 8 percent of GDP between the tenth and ninetieth percentiles. Regarding other economic variables, given our sample of Low- and Middle-Income Countries, we see on average high levels of food insecurity and high unemployment rates (37.82 percent and 8.75 percent respectively). Readings on other variables are very diverse, reflecting the variety of economies included in our sample. 10 Standard deviations of conflict variables are high reflecting a few extremely severe conflict episodes. We exclude these outliers in the regression analysis by removing the top 1% of observations, as noted above. INTERNATIONAL MONETARY FUND 14 Table 2 reports pairwise correlations among conflict-related variables, commodity ToT, and other economic variables. While a causal investigation is left for Section IV, the table presents several noteworthy facts. First, different conflict measures are positively correlated with each other, reflecting the close relationship among the number of conflict events, fatalities, and the evolution of conflict dyads. Second, the negative correlation between conflict variables and GDP per capita confirms a well-known association of conflict and income. The commodity ToT index is also negatively correlated with conflict variables, suggesting that deterioration of commodity ToT is associated with high intensity of conflict. Third, food insecurity and external debt are mostly positively correlated with the various measures of conflict. The Gini coefficient (a measure of inequality) and the unemployment rate are negatively correlated with all measures of conflict. These suggest the relevance of inequality and fiscal indicators for the occurrence of conflicts. At the same time, these indicators are clearly correlated with GDP per capita, which suggests a need for rigorous econometric analysis to identify the various statistical relationships. Table 1. Descriptive Statistics VARIABLE Observatio ns Mean Median Standard Deviation 10th percentile 90th percentile Number of conflict events (per million population) 4,412 3.19 0.00 32.54 0.00 3.31 Number of fatalities (per million population) 4,412 51.74 0.00 1392.17 0.00 32.82 Number of new conflict dyads 4,765 0.90 0.00 2.22 0.00 3.00 Number of continuing conflict dyads 3,232 1.08 0.00 2.45 0.00 3.00 Commodity ToT index 4,072 100.23 101.59 10.07 90.65 107.95 Low-Income and Lower Middle-Income Countries Number of conflict events (per million population) 2,696 3.98 0.00 34.78 0.00 4.95 Number of fatalities (per million population) 2,696 75.06 0.00 1774.51 0.00 56.70 Number of new conflict dyads 3,049 1.17 0.00 2.58 0.00 4.00 Number of continuing conflict dyads 2,336 1.21 0.00 2.69 0.00 3.00 Commodity ToT index 2,585 100.33 101.66 9.27 91.55 107.71 Upper Middle-Income Countries Number of conflict events (per million population) 1,749 1.95 0.00 28.38 0.00 1.67 Number of fatalities (per million population) 1,749 14.83 0.00 183.87 0.00 4.60 Number of new conflict dyads 2,092 0.36 0.00 1.14 0.00 1.00 Number of continuing conflict dyads 992 0.70 0.00 1.56 0.00 2.00 Commodity ToT index 1,611 99.87 101.28 11.33 88.04 108.42 Other Economic Variables GDP per capita (US$) 4,196 2,710.29 1,576.14 2,901.54 331.82 6,955.94 Gini coefficient 4,026 41.39 40.50 8.29 31.70 53.40 Unemployment rate (percent) 4,290 8.75 6.90 7.13 1.80 19.03 Food insecurity (percent of population) 2,574 37.82 36.50 22.18 11.20 72.50 External debt (percent of GDP) 4,323 62.03 42.56 77.63 -7.67 119.70 Fiscal balance (percent of GDP) 4,521 -2.77 -2.31 14.36 -37.59 2.73 INTERNATIONAL MONETARY FUND 15 Table 3 shows correlations of the commodity ToT index and its sub-categories, including the 4 broad categories mentioned above (food and beverages, raw agricultural materials, base metals, and energy), as well as crude oil. Interestingly, the correlations between the sub-categories and the ToT index are quite low (last row). While individual export and import price indices are highly correlated with individual commodity prices, the construction of the ToT index nets out the effects on the export and import sides, leaving the index specific to individual economies to reflect their net export structure. In other words, the dynamics of the ToT index capture a country’s income gains and losses, rather than just tracing the underlying commodity price fluctuations.Figure 5 shows how income shocks are expected to affect the incidence and intensity of conflicts via three channels outlined by the literature: (i) opportunity costs; (ii) state capacity; and (iii) predation. Table 2. Correlations N. of conflict events N. of fatalities N. of new dyads N. of cont. dyads Commod ity ToT index GDP pc. Gini coeff. Unemp. rate Food insecurity External debt Fiscal balance N. of conflict events 1 N. of fatalities 0.4946 1 N. of new dyads 0.2009 0.1557 1 N. of cont. dyads 0.2925 0.1154 0.6523 1 Commodity ToT index -0.121 -0.2014 -0.1335 -0.0369 1 GDP pc. -0.089 -0.0882 -0.119 -0.0187 -0.0152 1 Gini coeff. -0.02 -0.0132 -0.1117 -0.0386 -0.0292 0.1658 1 Unemp. rate -0.026 0.0115 -0.1244 -0.1481 -0.1989 0.1564 0.1826 1 Food insecurity 0.1017 0.1462 0.1473 0.0727 -0.0706 -0.3676 0.3016 -0.0544 1 External debt 0.156 0.2379 0.069 -0.0154 -0.2255 -0.2378 -0.0297 0.0315 0.1398 1 Fiscal balance 0.0189 0.0023 -0.0015 -0.0037 -0.0962 -0.0058 0.0475 0.038 -0.0055 -0.0634 1 INTERNATIONAL MONETARY FUND 16 Figure 5: Potential Channels of ToT Shock Effects on the Incidence and Intensity of Conflict Commodity price shocks can affect the opportunity costs of engaging in conflict activities. A negative commodity export price shock would lower household income, thus incentivizing households to engage in conflict. Case studies suggest that such a mechanism influenced the outbreak of the First Ivorian Civil War in the 2000s (Woods, 2003; McGuirk and Burke, 2020). In the 1980s and 1990s, Côte d’Ivoire experienced a persistent decline in the price of coffee and cocoa exports – products on which its economy relied heavily. The decline led the state and individual producers to expand their production to compensate for lower revenues. This resulted in competition over land that could be cultivated and the rise of ethnic and religious tensions, which promoted the context for the war. On the other hand, commodity import price increases reduce households’ real income, which also lowers opportunity costs. Schneider (2008) examines news reports and finds that food price increases in 2007 and early 2008 led to the eruption of food riots in more than 20 countries. The effect of a negative commodity ToT shock working through the state capacity channel is also expected to increase conflict intensity. A negative export price shock may lower government revenue, while import price increases may increase the fiscal cost of measures such as subsidies to support the population. In both cases, the state’s ability to mitigate the economic shock is weakened. For example, Sayne and Hruby (2016) describe that in Nigeria, Africa’s largest oil producer, falling oil revenue due to the oil price slump in 2014 and 2015, compounded by lower investor confidence and exchange rate volatility, constrained the government’s resources to address the expansion of Boko Haram in the northeast regions of the country. Finally, a negative ToT shock resulting from lower export prices would lower the gains to be made through rent capture, thereby decreasing incentives for conflict through the predation channel. Previous studies often report the significance of this channel for the oil and other natural resource sectors (e.g., Ross, 2004). Given the different expected direction of effect, the overall impact of commodity price changes on conflicts is ambiguous ex ante and requires careful regression analysis.