Four scenarios for war in Iran

After eliminating the top Iranian regime and bombing the Islamic Revolutionary Guard Corps for 40 days, the Trump administration failed to force a capitulation or prevent Iran from maintaining control of the Strait of Hormuz. After Iran targeted key infrastructure in Gulf Cooperation Council member states and threatened shipping, the United States returned to TACO (“Trump always chickens out”) mode by agreeing to a ceasefire. Now, rising inflation and slowing economic activity suggest a period of stagflation—just in time to anger voters ahead of the US midterm elections in November.

So what happens next? There are four possible scenarios.

First, the current ceasefire could lead to successful negotiations that would end military action and reopen the Strait of Hormuz. The United States has some leverage here, as its blockade of all maritime traffic to and from Iranian ports further increases financial pressure on the regime. Trump is likely hoping that a more moderate faction—perhaps led by Parliament Speaker Mohammad Bagher Ghalibaf—can convince hardliners that a compromise on the nuclear program will bring both sanctions relief and the restoration of shipping revenue through the strait.

This scenario, however, is not particularly likely, as the regime can endure economic pain for much longer than Trump (midterm elections are approaching). Moreover, the two sides remain far apart on many issues, not least Iran’s nuclear ambitions. The United States opposes Iran’s ballistic missile and drone programs, its support for radical Islamist groups in the Middle East, its proposed tariffs on shipping through the Strait of Hormuz, and other issues. Resolving even one of these issues will require long and complex negotiations between serious and experienced negotiators.

The second scenario reflects exactly that. The ceasefire holds, but negotiations drag on for several more months, while the strait remains blocked. This is essentially the state of affairs today, and it is far from ideal. The status quo is causing significant economic and financial damage to the world economy, with oil and energy prices continuing to rise, even surpassing the peak reached during the forty days of open war.

In such circumstances, the pace of global growth will weaken and inflation will rise. But the second scenario is inherently unstable and could not last more than two or three months. It would have to give way either to the first scenario (in which one side gives in and shows a willingness to compromise sufficiently to reopen the strait and secure a more lasting ceasefire) or to a new escalation of the conflict. After all, military incidents in the Gulf this week show how fragile any ceasefire without an agreement is.

In the third scenario, the US and Israel would escalate the conflict by activating all military, economic, and other means at their disposal to force capitulation or cause the collapse of the regime. In the event of capitulation, the regime would have to accept a complete halt to uranium enrichment and the unconditional opening of the straits. This would be the best outcome for the US, Europe, Asia (including China), and the rest of the world.

The risk, of course, is that the Iranian regime could survive such an escalation. In a fourth scenario, it would use its remaining ballistic missiles, drones, and naval forces to inflict serious and lasting damage on even more energy facilities in the Gulf, while maintaining control of the strait. If that were to happen, oil prices would soar to $200 a barrel or even higher, and the world would face 1970s-style stagflation, a global recession, and a stock market crash.

Of course, escalation could put pressure on both sides to find a negotiated solution, with the second scenario (status quo) having to go through a third or fourth before ending with the first. But that is less likely, because we would be back to negotiating a ceasefire again - and we have already seen how little such an agreement brings. Therefore, escalation could get out of hand rather than lead to a new ceasefire agreement.

Although Trump is hoping for the first scenario, it is probably just wishful thinking. The radicals and hardliners in Tehran currently have the upper hand. They have already shown their willingness and ability to withstand the economic pressure of the blockade, and they do not face elections this fall.

In terms of long-term economic and market consequences, the third scenario is ideal, as it would mean a permanent opening of the strait. The second best scenario would be the first; but it would imply that Iran could close the strait every time the US or Israel threatened it. This option would permanently keep oil prices 15-20% above pre-war levels. However, the current situation (the second scenario) is even worse, because every month that the ceasefire does not lead to an agreement will further slow global growth and raise inflation. The only worse outcome is the fourth scenario.

Given such serious risks, one can only wonder why global markets—most notably the U.S. and Asian stock markets—have recently hit new highs. I see two reasons for this. First, investors expect the ceasefire to somehow become permanent soon, which means significantly lower oil prices. Second, the prevailing assumption seems to be that the positive effects of the AI ​​and data center booms will remain much stronger than the negative effects of the war.

But if you believe that, you could be in for a nasty shock. Not only do markets price a lasting ceasefire (over 75%) more likely than reality suggests, but any escalation would lead to even greater economic and market instability, as well as additional downside risks even in the best-case scenario. While an escalation that would lead to regime capitulation would be more likely than one that would trigger stagflation like in the 1970s, markets would still underestimate the risk of damage in the meantime. For anyone on the wrong side of the trade, the pain would be no less if it lasted months rather than years or decades.

The author is Professor Emeritus of Economics at New York University's Stern School of Business; was Senior Economist for International Affairs on the White House Council of Economic Advisers during the Clinton administration; and has worked for the IMF, the US Federal Reserve, and the World Bank.

Copyright: Project Syndicate, 2026. (translation: NR)