You Decide: Is The Economy Headed For A Nosedive?

By Mike Walden

At the beginning of 2026, most economists, including me, were predicting a reasonably decent year for both businesses and households. We expected growth, a jobless rate between 4% and 4.5%, and a rise in worker earnings. Interest rates were trending downward and were expected to continue on that path. While price inflation would not be eliminated, it would hover around 2.5%, only slightly above the Federal Reserve’s goal of a 2% increase in prices for the year.

But forecasts have changed since the start of the Iran War. Economists are busy recalibrating their models and trying to assess what economic impacts the conflict will have. It seems to be clear that the conflict will have negative impacts. The questions are how negative and what that bad news will entail.

Wars can have both bad and good impacts on the economy. The bad impacts are obvious, including death and injuries to people, and destruction to buildings, property and infrastructure. However, wars can stimulate economic growth and can also generate new innovations. World War II helped the U.S. economy recover from the Great Depression by creating more production and jobs. Several innovations developed during World War II have had positive impacts that persist today, including jet engines, microwaves and penicillin.

Regarding the Iran War, the hoped-for benefits include peace in the Middle East and a consistent and reliable flow of oil from the region to the world. Some experts argue there has been a “terror premium” embedded in the price of oil that will be eliminated if Iran is defeated. The removal of the terror premium could send oil prices below their pre-war level.

But the focus now is on the economic costs of the conflict. One obvious cost is the price hikes we’ve seen in oil and gasoline. In economics, when the supply of an often-used product drops, its price rises. Gasoline is processed from oil, and world oil supplies have declined in the range of 5% to 10% since the war began. This has prompted an average 80-cent increase in the per-gallon gas price.

However, the price impacts of the Iran War go beyond gasoline. An estimated 40% of the world’s supply of fertilizer originates in the Middle East. Fertilizer is a key input for crop production. The war has already cut fertilizer supplies for farmers, which in turn increases both fertilizer and food prices. Some economists are predicting a doubling of food price inflation, with the annual rate jumping from 2% to 4%.

Lastly, the Middle East conflict has had an adverse effect on the stock market. The Dow Jones average is down 10% since the war began. While this has clearly hurt investors, there is also a broader impact. Research indicates aggregate consumer spending tends to drop when the stock market drops. Since consumer spending is the most important driver of the economy, stock market drops can lead to a broader economic contraction.

As a result of these trends, it shouldn’t be surprising that forecasts for a recession this year have increased. Some economists are now predicting a 50% chance for a downturn in the economy in 2026, almost double the chance prior to the start of the conflict. A recession means a decline in aggregate economic production, rise in unemployment and reduction in household income.

The outlook for inflation has also worsened. Forecasts in early 2026 put the year’s inflation rate around 2.5%. Now, many economists are expecting the 2026 inflation rate to be in the 3% to 4% range.

If we do see a recession and a higher inflation rate in 2026, we will have a “stagflation” economy. Economists define stagflation as an economy in a recession and with a rising inflation rate. This is unusual because during a recession consumers buy less, which in turn puts downward pressure on prices. But with stagflation, we get the worst of both worlds: fewer jobs and higher prices.

Of course, these worrying forecasts are dependent on how the events in the Middle East evolve. We are now entering the second month of the war. If the fighting is successfully concluded in a short period of time, then the economic forecasts will be much better. But if it continues for months, then the odds of the worrisome forecasts increase.

When trying to predict the future, I think it always helps to consider the positive and the negative. We are in that situation now. Which will occur? You decide.

Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.