Economy

War on Terrorism: Two months on

Before 11 September it looked as though America would probably have a recession. Now it looks certain to have a recession ... and that much of the rest of the developed world will too.

Key questions: two months on

Military campaign

Hearts and Minds

Economy

Opposition

Anthrax

Suspects

Bin Laden's money

Before 11 September it looked as though America would probably have a recession. Now it looks certain to have a recession ... and that much of the rest of the developed world will too.

The terrorist attack came at the worst possible time, striking the US economy just as it had started to turn down. The slowdown had been started by businesses cutting investment after the communications boom. But the economy as a whole had been sustained by consumers' willingness to borrow. Suddenly that confidence was shattered. While some types of spending continued, others – such as travel – dried up. Unemployment, already slowly rising, leapt upwards. That has further undermined confidence, and most private sector forecasters predict that the American economy will not recover until the second half of next year.

This is, of course, the world's largest economy. The second largest is Japan's. It was almost certainly already in recession this summer. This blow to its largest export market means not only that the recession will be deeper than it would otherwise have been, but that it may not be able to escape until Americadoes.

But everyone knew that the US might be in trouble and that Japan certainly was. The big new disappointment has been continental Europe. Until a couple of weeks ago the European Central Bank believed that the eurozone would largely escape the collapse elsewhere and the German authorities still expected reasonable growth. This week, by cutting rates by 0.5 points, the ECB acknowledged that it had been wrong. The German government has downgraded its forecasts – though it has yet to admit that the economy may actually shrink, as most private sector forecasters now expect.

That will probably (it is not yet certain) drag the entire eurozone into recession, for Germany accounts for one-third of the eurozone. The next biggest economy in the world, after Germany, is Britain, which is generally expected to carry on growing through 2002, albeit at a slower pace. But with numbers one, two and three in the world going down together, the UK (plus the other smaller European economies) are not big enough to stop the world going into a synchronised recession, the first since one that followed the oil shock of 1973-74.

The parallel is obvious but misleading on one crucial respect. That was an inflationary shock hitting a world that was already showing signs of excessive inflation. This is a deflationary shock hitting a world where many prices were already starting to fall. That crisis was met by high interest rates to crush inflation; this one is being met by plunging interest rates to try to counter deflation. Eventually the former succeeded; eventually the latter will succeed too. But the early 2000s, like the latter 1970s, will be a difficult time.