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Russia is attacking Europe with ‘the energy card,’ economist says

Simon Johnson, former IMF chief economist and professor at MIT’s Sloan School of Management, joins Yahoo Finance Live to discuss recessionary risks, Europe's energy crisis, and the European Central Bank continuing to raise rates.

Video Transcript

- Well, despite better polling numbers for President Biden of late, US voters may recall James Karvell's famous quote when he headed to the polls, saying exactly, it's the economy, stupid.

Well, people's sky high cost of living will no doubt be one of the main drivers ahead of November. But is the pessimistic view of the economy being overdone? Let's bring in Simon Johnson, former chief economist at the IMF and professor at MIT's Sloan School of Management.

Simon, it's good to talk to you today. It sounds like you're a bit more optimistic about the outlook, at least as it relates to the US economy.

SIMON JOHNSON: Yes. That's right, Akiko. I think we're making some progress on really important issues regarding innovation, job creation, and the way in which opportunity is spread around the country.

These are problems that have really stymied growth for a couple of decades. And now, partly because of the pandemic, partly because of how people have reacted to that and how they're thinking about work now, and also because of some recent bipartisan legislation, I think we're making progress.

- So some progress in terms of, as the president has said, more equal recovery, instead of some of the divides that we saw before. But the reality is, as Kevin just pointed out, inflation is still top of mind for a lot of Americans. And we're still looking at more than 8%.

To what extent do you think that can come down? I mean, what are you seeing as the key drivers, or key levers, aside from monetary policy?

SIMON JOHNSON: Well, as with regard to inflation, Akiko, I think the key issue is the global economy and how tight, or not, the global economy is. And as you know, there's a lot of discussion of a global recession or slowdown. That takes quite a bit of pressure off demand.

However, if that slowdown is concentrated in China, if it comes with more bottlenecks to supply, that is going to cut the other way. So it's a little too early to say on inflation.

I really don't think we overheated the economy in a general sense. I think many of the central bank reactions have been a little exaggerated. And I think that will become clear over the next three to six to nine months.

- Over in Europe, certainly, a lot of people are watching energy prices going up as well. Certainly, concerned about how things could look come winter during those critical months.

We saw the ECB today raising rates by 75 basis points. I mean, how do you see this all playing out, especially when you consider that a lot of this has been driven by what's playing out between Russia and Ukraine and there's no resolution in sight.

SIMON JOHNSON: Well, that's right, Akiko. Russia is attacking Europe. There's no other way to put it. Ukraine is on that perimeter that's being attacked.

But if you listen to what Mr Putin and his spokespeople say, they have much more expansionist designs. This is destabilizing. And they want to play the energy card, which obviously they've built up a real death grip, or a hard grip, on the throat of Europe through natural gas and to some extent also oil.

And they're determined to use that. It is going to be difficult for Europe, the European Union and other European countries, over the next year. But they're going to have to get off Russian energy because they can't live with Putin holding a dagger to their hearts.

So European economy is going to, I think, have to slow for these reasons. Yes, that's some inflationary pressure. Most of that energy price pressure through gas is felt in Europe.

What happens to oil, of course, matters for the world economy and for the US. And that's why the G7 is proposing a price cap on Russian oil, which I think will go into effect in early December.

- Yeah. How effective do you think that price cap can be? We're talking about G7 nations that have already imposed some pretty strict sanctions on Russia. There's still two big outliers in China as well as India.

SIMON JOHNSON: That's right. Those are the key questions, how China and India will react to the price cap. But the G7 and its friends and allies, obviously the Europeans, South Korea and Japan, do have the ability to set a differential price for Russia.

Russia already receives a significantly lower price for its Urals grade oil than Brent, for example. So this is increasing that discount. It is certainly doable. The details and implementation are being worked out now. And they have a couple of months to do that.

Remains to be seen if China and India want to pay more than the going rate for Russian oil. Well, they can do that if they want. Not sure why they would want to do that. They don't typically do that. They typically pay market rate.

And the G7 has the buying power to introduce this differential discount on Russian oil. So I think the prospects here are quite promising.

- What do you think the one risk is when we talk about the risks to the global economy that the market is overlooking? I mean, we've hit on some of the key issues.

We've been talking about what's happening in China with the Zero-COVID policy, over in Europe, here in the US, as well. But what do you think that, maybe, we're missing here in terms of what could be a significant risk?

SIMON JOHNSON: Well, I think the risk is that the Europeans will capitulate to Putin. Now, they obviously won't like it if I say that. They say that's not what they're doing.

But if you look at how they've implemented some of their sanctions, for example, the fourth package of sanctions which came into effect in May and June, it's really been weak, Akiko.

And they've had a lot of exemptions. They've allowed Greek shipping companies to do whatever the heck they want. They've allowed British insurance companies a lot of leeway also.

So I think there's a potential still for a lot of backsliding. Now, it would be, I think, in the medium run, quite self-destructive for Europe to do this. Putin is not going to be satisfied with grabbing some part of Eastern Ukraine or even all of Ukraine.

There's a fundamental threat to European security and European prosperity, and therefore, to the world. If the Europeans really work together, and I think the price cap is their next opportunity to do that, Putin can be stopped.

If the Europeans crack, and if they play off against each other, or if they put money above security, then we've got a different order of problem.

- Well, Simon Johnson, it's good to have you on today, former chief economist at the IMF and professor at MIT Sloan School of Management.