Nouriel Roubini: We can expect Israel-Iran hostilities to escalate

Initial statements from the Islamic Republic’s supreme leader suggested that Iran may not respond further. Markets seemed to agree, with oil prices falling 5% immediately after the Israeli strikes (even if they rose again somewhat a little later).

But this conventional wisdom is likely wrong. Israel’s assessment of the threat posed by Iran has shifted in the last few months. It is not just Prime Minister Binyamin Netanyahu and his right-wing allies’ views that have hardened; key leaders of the centre and centre-left opposition also argue that Israel should go further with strikes. 

Whether or not one agrees with that assessment, there is now a consensus there that the Iranian regime represents a clear and present danger. 

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With Iranian proxies Hamas, Hezbollah the Houthis and Shia militias in Iraq and Syria continuing to attack Israel, Israeli leaders have concluded that they must address the problem at its source. 

That could mean targeting Iranian nuclear facilities and eliminating the regime’s top military and political leaders, as done vis-à-vis Hamas and Hezbollah, actions which eroded the deterrent leverage that Iran had over Israel.

Owing to this change in the balance of power, Iran has only one effective option left to deter Israel now that even its offensive missiles and other weapons have failed to cause much damage: a dash to develop nukes. 

But since Israel regards a nuclear-armed Iran as an existential threat, it would have no other option than to attack Iranian nuclear facilities before it builds a viable device. 

So additional Israeli airstrikes are highly likely, regardless of Iranian restraint. Donald Trump in the US White House may give Israel a clearer green light to go after Iran.

If Israel starts escalating its attacks on Iran, possibly following new Iranian attacks against Israel, the US would continue to support it. Whether Israel has the capacity to destroy most of Iran’s nuclear programme or precipitate regime change in Iran is irrelevant; even limited damage to its nuclear facilities could set back its nuclear ambitions by a few years and establish deterrence.

The likelihood of escalation means economic and financial risks to manage. A large-enough Israeli strike on Iran could disrupt energy production and exports from the Gulf. 

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If Iran gets desperate, it could try to block the Strait of Hormuz, while also striking Saudi oil facilities. In this scenario, the world would face stagflationary shocks similar to those that followed the 1973 Yom Kippur War and 1979 Iranian revolution.

Oil-price spikes would be a disaster for the global economy and the welfare of billions of people, and policymakers should be thinking about how to soften the blow. It would help if a major conflict were as brief as possible. 

Israel would need to strike Iran hard and with precision. Maritime minesweepers would need to be rapidly deployed to clear Gulf sea-lanes as fast as possible.

The US would need to provide Saudi Arabia with advanced defence technologies to minimize the risk of Iran hitting its oil production and delivery facilities. 

And the Kingdom must massively increase its oil output and exports to reduce any potential global price spike, while the US and other powers should use their strategic oil reserves to dampen the impact further.

Governments in advanced economies and emerging markets can also introduce temporary fiscal subsidies for energy consumers, like those implemented following the price spike after Russia’s invasion of Ukraine in 2022. 

And central banks can respond to any stagflationary shock by holding policy rates steady or reducing them. With inflation expectations well anchored (unlike in the 1970s), central banks must not overreact by tightening in response to a shock that should prove temporary (lasting a couple of months or so).

Of course, since a full-scale Israeli attack on Iran would be highly risky, the US may be wary of the repercussions. In addition to the global economic fallout, a failure to destroy Iran’s nuclear facilities would only reinforce the regime’s decision to try to develop a weapon.

Success, though, could yield considerable dividends. The Iranian regime, a longstanding source of major instability in the Middle East, would be severely weakened; and if Iran is severely weakened, its proxies across the region would be too. 

Indeed, one cannot rule out a popular revolution in Iran after large-scale Israeli attacks. The regime is already weak, unpopular and resented by most Iranians. 

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If it falls, that could improve the conditions for achieving a ceasefire in Gaza, Israeli-Saudi normalization and eventually renewed talks toward a two-state solution for Israel-Palestine.

So, an Israeli attack against Iran is a high-risk, high-reward strategy that could lead either to a global economic disaster or to a reshaping of the Middle East for the better. 

That, at any rate, is how Israel see things, and further Iranian provocations against Israel are likely. Regardless of whether one agrees with the Israeli assessment, an escalation of the current conflict is highly likely. ©2024/project syndicate