War comes at bad time for global economy

With the United States and Europe struggling to shake off their recent doldrums, Japan mired in a punishing deflationary cycle, the global economy could have done without the weight of war with Iraq.

While economists are betting the conflict will be short and decisive - which they say could help unleash a solid recovery in the US and globally - nothing about the economic impact of war is certain yet, leaving policymakers from America to Europe uncertain about how to respond.

On Tuesday, the day before the first bombs fell on Iraq, US Federal Reserve said uncertainties were so great it simply could not gauge economic prospects. Instead, it pledged "heightened surveillance," implying it could cut interest rates if needed but making no commitment to any action.

"The hesitancy of the economic expansion appears to owe importantly to oil price premiums and other aspects of geopolitical uncertainties," the Fed said, adding it "believes that as those uncertainties lift," the economic climate should improve "over time." On Thursday, European policymakers echoed that sentiment.

"The impact of this military confrontation on the global economy can vary significantly in scope and size, depending on the extent and duration of the conflict," the European Central Bank said after a policy-setting meeting. "It is therefore not possible at this juncture to conclusively assess the short and medium-term implications for the euro area."

With the road to war far longer than expected, many economists have already pared their economic forecasts for this year - many by as much as half a percentage point.

International Monetary Fund head Horst Koehler has forecast global growth of just above 3 percent for 2003, down from 3.7 percent foreseen in September. But a prolonged conflict could shave as much as 2 percentage points off that forecast.

"If we had not been talking about and being on the verge of going to war for the past six months, the US economy would be doing a lot better already," said Bill Cheney, chief economist at John Hancock Financial Services.

"This has come at a time in the economic cycle when this type of apprehension could short-circuit the normal process of the recovery gathering momentum," he added.

New York Fed Bank President William McDonough said on Thursday Iraq-related uncertainty was not the only factor slowing a US business recovery, citing damage to investor and lender confidence by corporate scandals and a soft job market.

Economists have said repeatedly that the impact of the war on the world economy depends on duration as well as a host of variables - such as whether there is oil field damage, urban battles in Baghdad or use of weapons of mass destruction.

On balance, most economists expect a swift US victory. Should this best-case scenario unfold, said

Laurence Meyer, a former Fed governor now at the Center for Strategic and International Studies, stock markets and consumer confidence would rise and it would add a half percentage point to US growth this year.

However, President George W Bush has cautioned the war could be "longer and more difficult than some predict."

Whether short or lengthy, the conflict's impact on confidence will depend also on how long it dominates news coverage, said Ken Goldstein, chief economist of the Conference Board, a private group that tracks consumer sentiment.

"The question is at what point does Iraq fall off the radar," Goldstein said, noting conflicts in Bosnia, Kosovo and Afghanistan fell rapidly from newspaper front pages.

"The point is there will be heavy public attention for a month or two, not more, unless there is a massive terrorist attack, which will change everything," he added.

Conservative calculations of the cost of the war for the United States, which assume a swift campaign along the lines of the 1991 Gulf War, are about $100 billion, equivalent to 1 per cent of US economic output. No one knows the costs for sure because, as a New York Times editorial put it on Thursday, the Bush "administration remains about as transparent as a Stealth bomber in specifying the likely price." Nor will the costs end when hostilities cease.

The Council on Foreign Relations, a New York-based think tank, estimates that the price of rebuilding Iraq after the war will run $20 billion a year for "several years" - a cost expected to be borne mostly by US.

That will likely increase the size of US budget deficits, but economists expect that impact to be minimal given the scale of the $10 trillion US economy.

But even if the world's economy gets a short-term benefit from a decisive resolution to the Iraq crisis, not all economists see a smooth road ahead.

David Wyss, chief economist at credit rating agency Standard & Poor's in New York, is among those who think the war will provide a short-term boost to global economic prospects. But whether the world can maintain solid growth over the medium-term is another matter, he said.

According to Wyss, even if the war fades into history fast, the US economy will still face overcapacity, Japan will remain mired in stagnation and deflation and Europe will continue to underperform.

"Iraq has not been the only problem," Wyss said. "Even once that dark cloud lifts, it's still pretty foggy out there."