Persian Gulf War, 1991 ; War - Economic aspects ; Iraq

Adrian W.Throop

English

Research Papers in Economics

FRBSF WEEKLY LETTEA
Number 91-31, September 13, 1991
The Gulf War and the u.s. Economy
Wars generally stimulate aggregate demand in
an economy, and hence output and employment
in the short run, because of greater government
spending. In contrast, upward shocks to oil
prices generally are believed to have an imme-
diate contractionary effect on output and em-
ployment of countries importing oil, as real
consumer spending declines.
Iraq's invasion of Kuwait and the ensuing Gulf
War combined both a war and an oil shock. As
military forces were mobilized and deployed, the
price of oil temporarily doubled. This Weekly
Letter discusses the positive and negative effects
of the Gulf War on u.s. real GNP using a struc-
tural macroeconometric model.
Expansionary effects
Government spending. The most obvious effect
of the Gulf war on the u.s. economy was the ex-
tra stimulus given to demand from government
spending. The incremental costs of the Gulf war
to the United States were largely covered by con-
tributions from our allies. Some of these contri-
butions were in-kind, which obviously would not
have altered the demand for u.s. goods and serv-
ices. But the remaining cash contributions and
associated spending by the u.S. military had an
effect similar to ordinary debt-financed govern-
ment spending.
According to Data Resources, the extra Defense
Department purchases of goods and services at-
tributable to the Desert Shield and Desert Storm
operations rose from 0.2 percent of real GNP in
1990.Q4 to 0.5 percent in 1991.Q2. In real dol-
lars (1982 dollars at annual rates) this amounts
to $7.5 billion in 1990.Q4 and $22.4 billion in
1991.Q2. Military expenditures in this period
wouId have been greater, except that much of the
military equipment was supplied from invento-
ries. Some of these inventories will be replaced
later this year and next, showing up in the form
of higher government spending in the future.
Oil imports and oil profits. During the war oil
prices temporarily doubled, as supplies from
Kuwait and Iraq were shut off and the market
speculated about the future availability of oil.
Many users of oil drew down their inventories
instead of importing oil at temporarily high
prices. We estimate that oil imports were re-
duced by $19.0 billion in 1990.Q4 and $14.6
billion in 1991.Q1, in real dollars, due to this
speculative effect. Ordinarily a reduction in
oil imports would raise GNP as a result of the
stimulus given to domestic production. But in
this case a reduction in inventory accumulation
offset the effect of lower imports on GNP.
At the same time, high oil prices increased
the profits earned abroad by u.s. oil companies.
Such profits are treated in the GNP accounts as
the export of a service because they are a pay-
ment for the use of capital. We estimate that
these oil profits amounted to $8.0 billion in
1990.Q4 and $9.0 billion in 1991.Q1, in real
dollars. Thus, the effect of the war on oil profits
boosted real GNP in the United States.
Contractionary effects
Foreign GNP growth. Weaker growth abroad
exerted a contractionary effect on U.S. real GNP
by slowing the growth of exports. Since our ma-
jor trading partners also are oil importers, they
also suffered a negative oil shock. But since they
did not experience the same expansionary effects
from military spending as the U.S. did, the nega-
tive effect of the oil price shock dominated in
their economies. Real GNP growth in our major
trading partners dropped in 1990.Q4 and
1991.Q1, but then began to recover in 1991.Q2.
This slowdown in growth was relatively mild. For
example, overall growth in the group of 10 coun-
tries other than the United States remained posi-
tive, and thus as a group these countries did not
experience a recession. In the absence of the war
there would have been no oil price shock, and
real economic growth in our trading partners, on
average, probably would have continued at its re-
cent pace. We estimate that by 1991.Q2 the flow
of U.S. real exports was $16 billion, or 2~h per-
cent, lower than it would have been if foreign
output had not slowed.FRBSF
Consumer confidence and incomes. A second
contractionary effect of the Gulf War was on
consumer confidence and real incomes. Higher
oil prices had the effect of reducing the purchas-
ing power of household incomes, which in turn
tended to reduce consumer spending of all kinds
in real terms. But besides this income effect,
there was also an adverse effect of the war on
consumer confidence, and hence spending
on consumer durables and housing.
Consumer confidence, as measured by the
University of Michigan survey, dropped by 28
percent between the second and fourth quarters
of 1990, and then recovered over half of its pre-
vious decline by 1991.Q2. Research at this bank
(see FRBSF Weekly Letter ofJuly 19, 1991) has
shown that survey measures of consumer confi-
dence importantly affect expenditures on con-
sumer durables and housing. Normally, however,
consumer confidence is driven by movements in
economic variables, and movements in confi-
dence that are not associated with these variables
usually have little or no influence on household
expenditures. The economic variables that ap-
pear to have the most significant influence on
consumer confidence are the overall inflation
rate, changes in oil prices, and changes in the
unemployment rate.
But the Gulf War appears to be the "exception
that proves the rule:' Consumer confidence
dropped significantly more than could be ex-
plained by these economic variables, and the
"unexplained" portion of the drop in confidence
appears to have had a significant impact on ex-
penditures on consumer durables and housing.
Consequently, we include in the effect of the
Gulf War not only the impact of higher oil prices
on consumer confidence, but also the "unex-
plained" portion of the drop in consumer confi-
dence. (The impact that the Gulf War had on
consumer confidence through its effect on infla-
tion and unemployment is determined through
the econometric model's estimate ofthe effects
ofthe war on those variables.)
Business Confidence. In recessions, the ratio
of inventories-to-sales usually rises because
producers are slow to cut back their inventories
when sales decline. The recession during the
Gulf War was different, however, in that inven-
tory-to-sales ratios generally fell. Thus, the ratio
of real nonfarm inventories to real final sales
dropped fairly steadily from 2.43 in 1990.Q2
to2.36 in 1991.Q2; and the ratio of real retail
inventories to real goods consumption was
approximately 2.75 from 1990.Q2 through
1990.Q4, and then fell to 2.36 in 1991.Q2.
Widely publicized declines in consumer confi-
dence and analysts' dire predictions of the war's
effects led businesses to anticipate future de-
clines in sales. This prevented any rise in the
overall inventory-to-sales ratio. The result was
somewhat similar to the 1980 recession when
the imposition of credit controls also led business
to anticipate reductions in sales, producing only
a slight increase in inventory-to-sales ratios.
The inventory equation in the macroeconometric
model that is used for estimating the effects of
the Gulf War developed significant overpredic-
tions of nonfarm inventory investment beginning
in 1990.Q4, even though it had predicted past
cyclical turns in inventory investment quite well.
Therefore, these errors in the model's predictions
are attributed to the effects of the Gulf War on
expectations of business (and also to temporarily
lower petroleum imports, as discussed earlier).
Similar errors in the model's predictions of busi-
ness fixed investment also began to develop in
1990.Q4, as expectations of falling sales led firms
to postpone plans for capital expansion. These
too are attributed to the war.
Net effect of the Gulf War
The effect on U.S. real GNP of these various
influences was estimated using a structural
macroeconometric model. It was assumed that
the Fed conducted monetary policy to maintain
the same path for u.s. short-term interest rates as
actually occurred. One could have assumed al-
ternatively the same path as actually occurred for
some monetary aggregate, such as M2. However,
over ashort four-quarter period the results would
be fairly similar.
Chart 1 shows the impact on U.S. real GNP of
each of these influences taken separately. Gov-
ernment spending and the effect of the war on
oil imports and oil profits had expansionary ef-
fects, but the effects of foreign real GNp, con-
sumer confidence and incomes, and business
confidence (including the speculative decline in
oil inventories) were contractionary. The adverseeffects on consumers and on business were par-
ticularly large, together reducing u.s. real GNP
by over $100 billion, in 1982 dollars, by 1991.Q1.
4,200
1982 Dollars
4,300
1991
Estimated Real GNP in
Absence of Gulf War
1990
Adrian w. Throop
Research Officer
Chart 2
Total Estimated Impact
of Gulf War on Real GNP
]
" 100
0"1--'0'2---0"3---0"4---0"1--024,000
Had the war not occurred, real growth would
have been sluggish, at a 1.4 percent rate in the
last half of 1990 and a 0.8 percent rate in the first
half of 1991. As a result, the civilian unemploy-
ment rate would have risen from 5.3 percent in
1990.Q2 to 6.2 percent in 1991.Q2, but not as
high as the actual 6.8 percent figure. The 5.3
percent unemployment rate was associated with
a labor market that was generating upward pres-
sure on inflation. Consequently, a temporary
period of slow growth would have kept demand
within the bounds of the economy's capacity to
produce and helped to keep inflation in check.
o
·20
·80
02
1991
01 04 03
1990
Q2
Consumer ........~.... - - --- _
Confidence and Income ........... Foreign GNP
···~"'~ ....L"···· ·40
Business Confidence ·60
01
Chart 1
Estimated Impacts
of Gulf War on Real GNP 1982 Dollars
Federal Government Spendinq 40
Oil Imports and Profits ~-:3 20 .... ......
Chart 2 shows the estimate of the path of u.s.
real GNP in the absence of the Gulf War. This
is obtained by removing all of the expansionary
and contractionary influences of the war on GNP
that are shown in Chart 1. As can be seen in
Chart 2, it is estimated that in the \AJar's absence
growth would have been slow, but there would
not have been a recession. Instead of declining at
a 1.6 percent annual rate in 1990.Q4, it is esti-
mated that real GNP would have grown at a 0.7
percent rate; and instead of falling at a 2.8 per-
cent rate in 1991.Ql it would have advanced at
a 1.5 percent rate. In 1991.Q2 it would have
dropped at a 0.5 percent rate instead of a 0.1
percent rate.
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Judith Goff) or to the author.... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974·2246.OHt>6 \>') 'o:>sPUl!J:I Ul!S
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Index to Recent Issues of FRBSF Weekly Letter
DATE NUMBER TiTlE AUTHOR
3/8
3/15
3/22
3/29
4/5
4/12
4/19
4/26
5/3
5/10
5/17
5/24
5/31
6/7
6/14
7/5
7/19
7/26
8/16
8/30
9/6
(91-10)
(91-11)
(91-12)
(91-13)
(91-14)
(91-15)
(91-16)
(91-17)
(91-18)
(91-19)
(91-20)
(91-21 )
(91-22)
(91-23)
91-24
91-25
91-26
91-27
91-28
91-29
91-30
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The Gulf War and the U.S. economy

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