Before US President Donald Trump launched his war of choice against Iran, financial markets were booming in many countries, and private-sector confidence was recovering. But the outlook has suddenly become bleaker, and many governments have only limited policy buffers available to cushion the inflationary shock.
ITHACA—Before Donald Trump launched his war of choice on Iran, the world economy was poised for a year of decent growth despite structural headwinds resulting from trade-policy volatility, rising public debt levels, and geopolitical fragmentation. The latest update to the Brookings-FT TIGER (Tracking Indexes for Global Economic Recovery) shows that financial markets were booming in many countries, and that private-sector confidence was recovering. Moreover, the US Supreme Court’s ruling against Trump’s “Liberation Day” tariffs was a positive omen for world trade, even if it did not ensure a predictable path forward.
But the Iran war has thrown the world economy off track and will almost certainly lead to a spike in inflation. How long that spike lasts, and whether growth will be dented substantially, depends on how quickly the war ends. The lack of a resolution to the conflict in the next few weeks, combined with the possibility that the war could engulf broader swaths of the Middle East, poses a substantial danger to the global economic outlook.
The two key questions, then, are whether the war will end relatively soon and without further substantial damage to energy infrastructure in the Gulf; and whether it will end in a way that allows for durable regional peace. Because the situation remains highly fluid, we will focus on the underlying sources of pre-war growth momentum in major economies, as this provides a baseline for evaluating how seriously the war could affect macroeconomic prospects.
For its part, the US economy seemed to be on track for another year of healthy growth, despite some indications of slowing labor-market momentum. Inflation had stabilized, albeit at a level above the US Federal Reserve’s 2% target, and strong consumer spending, continued investment in AI, and rising productivity were powering the economy and stock markets. Yet now, the Iran war presages a further increase in deficit spending and federal debt, with Treasury bond yields rising significantly as a result. The dollar, which had weakened somewhat earlier in the year, has strengthened as investors search for safety.
Economic performance in the eurozone remained uneven as this year got underway. France continued to struggle with a budget overhang, turbulent politics, and weak consumer spending, while Germany was set for a modest recovery, but with private-sector confidence still fragile. The Netherlands, Italy, and Spain had stronger growth momentum. But eurozone countries’ dependence on imported energy and robust foreign demand for their own exports leaves them vulnerable to price hikes, which could stunt growth or perpetuate a broader global downturn.
Japan, also a major energy importer, confronts a similar set of challenges, including the possibility of higher inflation, especially if the yen continues to weaken. The United Kingdom remains beset by falling private-sector investment, as well as weak consumer spending and productivity growth. Neither country has much room to use fiscal policy to soften the blow from higher energy prices.
Then there is China, whose economy showed signs of stabilizing earlier this year. Exports were still the main growth engine, but domestic consumption, investment, and industrial production were beginning to pick up. China’s fossil-fuel reserves, combined with its progress in adopting cleaner alternatives, are likely to shield it temporarily from the worst effects of energy-price hikes.
China also has room to leverage both monetary and fiscal policy to buffer the shock in the short run. But its government has shown no urgency in addressing deep-rooted problems in real estate, financial markets, and the structure of public finances, not to mention an unbalanced growth model characterized by weak household consumption.
India appeared poised for another year of banner growth with low inflation, disciplined fiscal policy, and a resurgent manufacturing sector; but these trends are now in doubt. India’s dependence on imported energy leaves its consumers and manufacturers highly vulnerable to price spikes—worries that are reflected in a sharp depreciation of the Indian rupee and falling equity prices. At the same time, rising oil prices could provide a boost to the Russian economy, which might have the side effect of prolonging the war in Ukraine, adding to geopolitical instability.
Finally, the Iran war has dealt a particularly severe blow to low-income economies, many of which had seemed poised for a breakout year of growth. These economies depend heavily on imported fertilizer, oil, and gas, and roughly half of their household expenditures go to food and energy. Since most lack policy space, the spike in energy and food prices will severely damage their growth prospects.
This is an extraordinarily challenging time for policymakers, all of whom are looking for ways to shield their economies and citizens from the economic impact of the war. Central bankers, in particular, are caught in a difficult bind as they weigh the twin risks of a prolonged spike in inflation and weakening growth.
Many major advanced economies’ public finances are already strapped. High fiscal deficits and debt levels leave little room for maneuver, and rising interest rates in some countries are making matters worse by adding to governments’ debt-service costs. With economic and geopolitical instability having become the new normal, the Iran war highlights the importance of maintaining policy buffers and investing in economic resilience.
About the Authors:
Eswar Prasad is Professor of Economics at Cornell University and a senior fellow at the Brookings Institution, is the author of The Doom Loop: Why the World Economic Order Is Spiraling into Disorder (Hurst & Company, 2026).
Caroline Smiltneks is an undergraduate at Cornell University.