Economic Analysis of Terrorist Attack: Long-term Predictions are not as Bleak as Many Expected

In the very short-run, these attacks will clearly have a negative effect on our economy, simply by disrupting normal business activity.  Many financial enterprises had offices in the twin towers, so financial markets will be impacted.  Also the cessation of air traffic will disrupt the flow of people and goods throughout the country.  But the Fed has announced a willingness to provide as much liquidity as banks need to keep financial markets operating smoothly.  And the backlog in air traffic should eventually clear.  I have also heard that businesses, such as the U.S. Postal Service, are starting to employ trucks to get around the stoppage in air traffic. 

In terms of the manpower lost, although catastrophically high from a humanitarian standpoint, it actually is a small fraction of our economy, so that effect will be hard to discern.  The larger concerns from an economic standpoint are how this is going to affect consumer and business confidence.  The one component of aggregate demand that has sustained our economy over the past year has been consumer spending.  That is what has kept us barely out of a recession.  If that declines because of anxiety about the world, that could easily tip us into a recession.  Business spending is already depressed, but that too could decline even further if firms perceive the future to be even riskier now.

A lot is riding on how our government responds to the events of this week and whether they can restore a sense of calm and order.  Government spending could actually boost GDP as there is talk of Congress allocating tens of billions of dollars in aid to New York City.  In a rather perverse way, GDP can rise after disasters because of the surge in spending on cleanup and repair. 

One big question mark is what all of this will do to oil prices.  If these attacks precipitate worries about disruptions in world oil supplies, that could send oil prices way up, which obviously would hurt the US.  But because I see no reason right now to believe that these events will lead to something like a war in the Middle East, which would interrupt oil supplies, I am hopeful that oil prices will eventually stabilize at fairly normal levels. 

All in all, I am optimistic that our huge economy can weather these attacks well.  The fundamentals of our economy are still sound; we have a wonderfully skilled labor force, sophisticated capital, state of the art technology, and a market system that allocates those resources rather efficiently.  None of that has changed.  As long as we recognize that and don’t panic, our economy will continue to thrive.