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

Key takeaways:

A diplomatic settlement of the Iran war would bring some immediate economic relief, yet the extensive physical destruction of infrastructure critical to Iran and its neighboring Persian Gulf countries means global and U.S. economic growth will likely continue to suffer.
In March, U.S. households suffered the largest one-month price increase in gasoline and diesel fuel since recordkeeping began in 1967.
Persistent inflationary pressures due to higher energy costs alongside volatile U.S. tariff policymaking could compel the Federal Reserve to keep interest rates high, tightening credit for businesses and slowing growth.

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 and heightened inflation 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 in tariff policymaking itself by the second Trump administration as firms are forced to hold off on making growth-driving investments and hiring. The Iran war has only made things worse by disrupting key trade routes and imposing even greater policy uncertainty.

Consumer price data 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. 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, 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 that would raise prices in the United States. These costs will drag down U.S. economic growth, similar to the effect of tariff costs.

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 damage already 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 in funding infrastructure repairs and rearmament, pulling back on sovereign wealth fund 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 remain. Confusion over peace terms, particularly regarding Lebanon’s inclusion in the ceasefire, underscores the deep uncertainty pervading the conflict, compounding volatility 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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