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Macroeconomic consequences of terror: theory and the case of Israel

  • Eckstein, Zvi
  • Tsiddon, Daniel

This Paper analyses the effect of terror on the economy. Terror endangers life such that the value of the future relative to the present is reduced. Hence, due to a rise in terror activity, investment goes down, and in the long run income and consumption go down as well. Governments can offset terror by putting tax revenues into the production of security. Facing a tide of terror, a government that acts optimally increases the proportion of output spent on defense, but does not fully offset the tide. Thus, when terror peaks, the long-run equilibrium with an optimizing government is of lower output and welfare. Next, we show that this theory of terror and the economy helps to understand changes in trend and business cycle of the Israeli economy. The estimates show that terror has a large impact on the aggregate economy. Continued terror, at the level of the death toll by about the same size as due to car accidents, is expected to decrease annual consumption per capita by about 5% in 2004. Had Israel not suffered from terror during the last three years, we estimate that output per capita would have been about 10% higher than it is today.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 51 (2004)
Issue (Month): 5 (July)
Pages: 971-1002

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Handle: RePEc:eee:moneco:v:51:y:2004:i:5:p:971-1002
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  2. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  3. Manuel Trajtenberg, 2003. "Defense R&D Policy in the Anti-terrorist Era," NBER Working Papers 9725, National Bureau of Economic Research, Inc.
  4. Joel Slemrod, 1988. "Fear of Nuclear War and Intercountry Differences in the Rate of Saving," NBER Working Papers 2801, National Bureau of Economic Research, Inc.
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