Why the Iran war is bad for U.S. economic growth

Key takeaways:

Overview

The growth trajectory of the U.S. economy is highly dependent on its connections to the outside world through trade and investments, as well as foreign policy and geopolitical developments. That global link was already under strain before the United States and Israel launched their war against Iran in late February because volatile U.S. tariffs and retaliatory trade policies had disrupted transnational supply chains and contributed to political tensions with traditional allies of the United States.

Recent research shows that tariffs imposed since the so-called Liberation Day last year caused a decline in U.S. imports (opens in a new tab) and heightened inflation (opens in a new tab) relative to the pre-tariff trend, with tariff costs distributed unevenly across U.S. industries. The direct costs of tariffs to U.S. businesses and consumers today are compounded by the volatility (opens in a new tab) in tariff policymaking itself by the second Trump administration as firms are forced to hold off on making growth-driving investments (opens in a new tab) and hiring. The Iran war has only made things worse by disrupting key trade routes (opens in a new tab) and imposing even greater policy uncertainty.

Consumer price data (opens in a new tab) released in March showed that U.S. households suffered the largest one-month price increase on record for gasoline and diesel fuel, eating into budgets already under strain from a widespread affordability crisis (opens in a new tab). Airfare prices also accelerated significantly. Reliance on fossil fuel-powered transportation for the movement of goods across the country means U.S. businesses have few alternatives to paying higher prices.

If domestic fuel prices remain elevated over an extended period (opens in a new tab), then prices for other household items could also begin to rise as businesses pass on transportation costs to consumers. Trade disruptions also are hitting fertilizer shipments out of the Persian Gulf, threatening a global food crisis (opens in a new tab) that would raise prices (opens in a new tab) in the United States. These costs will drag down U.S. economic growth, similar to the effect of tariff costs (opens in a new tab).

In the face of persistent price inflation, the Federal Reserve will be less inclined to cut interest rates and could even feel pressure to raise rates. Persistent inflation and tight credit over the medium to long term could contribute to a broader stagflationary trend for the U.S. economy as firms continue to pull back on investments and hiring.

The U.S. stock market—a gauge of investor sentiment, not broader economic health—has largely recovered since the advent of the war, as hope for a lasting ceasefire grows. But a quick diplomatic settlement, itself an unlikely outcome, will not magically undo the physical (opens in a new tab) damage (opens in a new tab) already (opens in a new tab) caused by the war. Infrastructure damage in Iran and the member nations of the Gulf Cooperation Council—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates—means costly repairs and reduced oil and gas output for months or even years. Wells that have been shut down, either for safety reasons or because storage facilities are at capacity, are subject to costly and complicated reopenings. Additionally, these countries could face fiscal constraints (opens in a new tab) in funding infrastructure repairs and rearmament, pulling back on sovereign wealth fund (opens in a new tab) investments in order to offset losses.

The existing ceasefire is clearly tenuous. Negotiators on both sides appear willing to engage in further talks, though significant gaps (opens in a new tab) remain. Confusion over peace terms, particularly regarding Lebanon’s inclusion in the ceasefire, underscores the deep uncertainty pervading the conflict, compounding volatility (opens in a new tab) in the stated goals of the United States in the war.

Altogether, the direct costs of the Iran war in terms of elevated fuel prices, snarled supply chains, and decimated energy infrastructure will weigh on U.S. economic growth as businesses pass down costs and pull back on investments and hiring. A lack of clarity around the purpose and goals of the United States in the war means businesses are doubling down on the wait-and-see approach they adopted amid the country’s volatile trade war with the world.

A diplomatic settlement to the Iran war at some point would bring some immediate relief. But extensive physical destruction to critical infrastructure in Iran and around the Persian Gulf means U.S. economic growth will likely continue to suffer over the medium term to long term.

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