Iran conflict’s economic knock likely just the beginning

2026-03-29 - 16:04

The escalating conflict involving Iran is a significant shock to the global economic system, sending tremors through financial markets, energy prices, and the fragile confidence that underpins investment decisions worldwide. A century of economic data tells us what happens when geopolitical risk spikes: investment falls, prices rise, and downside risks multiply. New Zealand households are already feeling it – and the worst may still lie ahead. The primary driver of economic disruption in times like these is uncertainty. When military tensions flare, businesses defer investment, households pull back spending, and financial markets scramble to reprice risk. Right now, uncertainty is rising sharply. Economists have worked hard to quantify something as diffuse as geopolitical anxiety. In an important contribution published in the American Economic Review, Federal Reserve economists Dario Caldara and Matteo Iacoviello developed the Geopolitical Risk Index – a measure constructed by tracking how often leading international newspapers publish articles referencing geopolitical tensions, adverse events, and associated risks. Their historical index reaches back to 1900, offering an unprecedented long-run view of how geopolitical stress evolves over time. The spikes in that index are a roll call of catastrophe: World War I, World War II, the Korean War, the Cuban Missile Crisis, and the September 11 attacks. Each of these moments, captured in the data as surges in newspaper coverage, corresponds to periods of profound economic and financial disruption. What Caldara and Iacoviello found is striking. Higher geopolitical risk is typically followed by lower business investment, declining stock prices, and weaker employment. More troubling is that elevated geopolitical risk is associated with a higher probability of economic crises and greater downside risks to the global economy. In other words, the damage is not symmetrical: when geopolitical conditions worsen, the bad outcomes tend to be worse than the good outcomes are good. World geopolitical risk index surges Source: Matteo Iacoviello/BNE Intellinews This asymmetry matters enormously right now. The current conflict sits at the intersection of several sensitive pressure points, including oil supply routes, regional alliances, nuclear concerns, and great-power rivalries. Each of these dimensions adds another layer to the uncertainty that markets and policymakers are trying to price. The inflation threat Beyond the immediate hit to confidence and investment, there is another danger: inflation born of disruption, scarcity, and the fiscal pressures of conflict. New research published in the Journal of International Economics by Caldara, Iacoviello, and colleagues addresses this directly. Drawing on historical macroeconomic data covering 44 economies since 1900, their findings show that geopolitical risks tend to foreshadow higher inflation. The effect varies in strength across countries and historical periods, but the direction is consistent. Conflict is inflationary. What this means for New Zealand New Zealand is a small, open economy deeply integrated into global trade and financial flows. We are price-takers on world markets, meaning disruptions we did not cause and cannot control pass directly through to households and businesses. The latest data suggest that this transmission is already underway. The Westpac McDermott Miller Consumer Confidence Index, released on March 18, captured New Zealand households’ sentiment in the first two weeks of March – precisely the period in which the Middle East conflict escalated. The headline index fell to 94.7, below the threshold of 100 that separates optimists from pessimists. More telling was the collapse in forward-looking sentiment: the Expected Conditions Index dropped 4.2 points, and the one-year economic outlook measure fell by more than five points in a single quarter. The report’s own headline, ‘The fog of war’ captures the mood precisely. Westpac’s economists note that many households surveyed had not yet felt the full impact of the conflict or experienced the sharp rise in fuel prices that followed. That is a sobering caveat. The Commerce Commission’s fuel-monitoring data shows the average retail price of 91 unleaded rose by 55 cents per litre between February 28 and March 18, while the Westpac McDermott Miller survey recorded a 63-cent rise by the time households were surveyed. Increases in fuel prices ripple quickly through transport, logistics, food prices, and airfares. The Reserve Bank of New Zealand faces a particularly uncomfortable outlook. Geopolitical shocks of the kind now unfolding tend to be stagflationary, pushing prices up while simultaneously weakening growth. The Reserve Bank of Australia’s March monetary policy statement was explicit: “A longer or more severe conflict could put further upward pressure on global energy prices; this will push up near-term inflation and could also increase inflation further out if it impairs supply capacity or price rises get built into longer-term inflation expectations. Higher prices and prolonged uncertainty may cause growth to be lower in Australia’s major trading partners and also in Australia.” The research by Caldara, Iacoviello, and colleagues suggests that not only does geopolitical risk raise average inflation, it also increases inflation uncertainty, making the Reserve Bank’s already-difficult task of anchoring expectations considerably harder. The Westpac survey was taken when the conflict was still in its early stages. If it intensifies or persists, the confidence knock we have already seen is likely only the beginning. Policymakers, businesses, and households would be wise to plan accordingly.