In the fourth scenario, the conflict also spreads across the region but there is regime change in Iran. If Israel and the US do end up attacking Iran, they will target not only nuclear facilities but also military and dual-use infrastructure, as well as regime leaders. Rather than supporting the regime, Iranians – who have been protesting morality-police abuses for over a year – may rally behind moderates like former President Hassan Rouhani.
The toppling of the Islamic Republic would allow Iran to rejoin the international community. There would still be a severe global stagflationary recession, but the stage would be set for greater stability and stronger growth in the Middle East.
How likely is each scenario? I would assign a probability of 50% to the preservation of the status quo; 15% to a post-war outbreak of peace, stability, and progress; 30% to a regional conflagration, and only 5% to a regional conflagration with a happy ending.
The good news, then, is that there is a relatively high chance – 65% – of the conflict not escalating regionwide, implying that the economic fallout would be mild or contained. The bad news, however, is that markets are currently assigning only at best a 5% probability to a regional conflict that would have severe stagflationary effects around the world, when a more reasonable figure is 35%.
Such complacency is dangerous, especially considering that the combined probability of a globally disruptive scenario (one, three, and four) is still 85%. The most likely scenario might have only mild short-term consequences for markets and the global economy, but it implies that an unstable status quo will remain in place, eventually leading to new conflicts.
For now, markets are priced for near-perfection and favor the mildest scenarios. But markets have often mispriced major geopolitical shocks. We should not be surprised if it happens again.
Nouriel Roubini, professor emeritus of economics at New York University’s Stern School of Business, is chief economist at Atlas Capital Team, CEO of Roubini Macro Associates, co-founder of TheBoomBust.com, and author of "MegaThreats: Ten Dangerous Trends That Imperil Our Future," and "How to Survive Them" (Little, Brown and Company, 2022). He is a former senior economist for international affairs in the White House’s Council of Economic Advisers during the Clinton administration and has worked for the International Monetary Fund, the U.S. Federal Reserve, and the World Bank. His website is NourielRoubini.com, and he is the host of NourielToday.com.