The Economic Impacts of the Terrorist Attacks in the USBy the Oxford Economic Forecasting

The tragic events in New York, Washington DC and Pittsburgh on 11 September clearly have massive human and political implications. In addition, the terrorist attacks potentially have serious economic implications, not only for the US but internationally.

This note summarises OEF’s initial assessment of the economic impact of the attacks. While it is still too soon to be able to be able to judge with much confidence the likely scale of these economic effects, there are some precedents on which we can draw, such as the 1990 Gulf War.

It should be stressed, however, that while the human cost of the tragedy cannot be overstated, economists very often exaggerate the scale of the effects of such events on GDP growth, inflation etc. We should therefore be cautious in revising forecasts significantly at this stage.

Judging by experience in response to similar past shocks, we might expect to revise down our forecast for US growth over the next year by ½% at the very most, especially given the likely monetary policy response in those circumstances, with the impact on the rest of the world commensurately smaller.

But the terrorist attacks come at a time when the US economy is already looking vulnerable, as a result of the falls in equity markets over the last year, the collapse in the TMT sectors and recent increases in unemployment. There is a risk that the attacks trigger a substantial loss of consumer and business confidence that hits spending and financial markets, feeding back onto unemployment and household incomes, and creating a vicious spiral into recession.

Our assessment is that the impact of the attacks on confidence may have increased the risk of a US recession to perhaps 35% now compared with an already worrying 20% previously.

We begin by discussing the likely impacts of the attacks on financial markets and monetary policy. We then discuss implications for consumer and business confidence in the US, and international ramifications. Finally, we discuss implications for travel and for industrial sectors.

(a) Financial market and monetary policy impacts

Equity markets fell sharply following the terrorist attacks, with the FTSE 100 dropping

almost 6% to below 4700, the DAX down over 8% and the Nikkei down over 7%. Equity

indices have steadied today but, with the US market closed, lack a clear sense of direction.

Similar sharp falls in equity markets were seen after the Iraqi invasion of Kuwait in 1990 – for example, the Dow dropped by about 8% in the following week. But as the Chart below shows, these falls were short-lived and markets generally recovered that lost ground once the Gulf War had finished in early 1991, even though the US and much of the OECD was by then in recession and company earnings were weak. (The Nikkei is an obvious exception.)

It remains to be seen whether equity markets will fall further following the latest terrorist

attacks. But with central banks making clear that they stand ready to inject liquidity into the markets if necessary, and cut interest rates if appropriate, we would expect to see equity markets recover once the security situation is seen to have stabilised in much the same way they did following the ending of the Gulf War.

Of course, this may take some time, and in the meantime lower equity prices will tend to depress growth. As a ready reckoner, our model suggests that a fall of 10% in the major equity markets for a six month period would reduce growth in the major economies by only around 0.1% in 2002, although this assumes no adverse confidence effects (but see section (b) below).

Oil prices rose sharply following the attacks, with October Brent closing up about $1.6 pb at just over $29 pb, but have fallen back somewhat today. There is clearly a danger, however, that the oil price could rise even further if there is an escalation of tension in the Middle East, particularly if there are US reprisals on countries it judges to be responsible for the ter