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KAREN GIBBS: But back to that possible war with Iraq. Just how much will it cost? Joining us to discuss that issue, Laurence Meyer, who warns that in a worse case scenario, war with Iraq could plunge the global economy into recession. Larry is a former governor of the Federal Reserve Board and now a distinguished fellow at the Center for Strategic and International Studies. Mark Zandi, who runs Economy.com, spends his days helping business leaders figure out where the economy is headed. If there's a quick and decisive war, he sees room for optimism. Gentlemen, welcome. Larry, let me start with you, because a lot of investors, and pretty much the stock market, has priced in a very quick and successful war. What if we're wrong? What are the risks to the economy if this becomes a prolonged, protracted affair?

LAURENCE MEYER: Well, I think there are risks. I think the benign, quick, decisive war is the most likely outcome. When it comes to putting together a forecast, that's what we've assumed in our baseline forecast. But obviously what we see in the market, the impact I think on equity prices, on business decisions, reflects the fact that people are looking at possibly darker and more adverse outcomes, at least the possibility. So at least there are non-trivial possibilities of far worse outcomes, depending on, for example, whether there's damage to the oil fields in Iraq and in the region, whether use of weapons of mass destruction, major terrorist events, political de-stabilization in the area. So there are a lot of, when you see the checklist that you have to, the assumptions you have to make to get the benign scenario, you know there are other possibilities.

GIBBS: Well, I saw some of the numbers that you created, and it said that the Wilshire 5000 total market index -- 98 percent of U.S. companies are in it -- it could fall 3,000 points, the GDP could drop 4.5 points from its current level, and the unemployment rate could rise 2 percent from its current level. Is our economy strong enough to withstand those types of modest shocks?

MEYER: Well, obviously that would be a global recession. That would be the unemployment rate up to 7.5 percent. That would be a very serious problem. Can we withstand it? Yes. I mean we'll work through it, but it will a very adverse event and it will be very difficult. But, you know, I don't like to see the study that we did sort of characterized in terms of the worse case scenario. That was the least likely outcome. I think it's important to say that there's not a single possibility here. We don't want to give too much attention to the benign case. On the other hand, we don't want to give too much emphasis to the worse case scenario, which was the lowest probability.

GIBBS: Well, Mark, like we said, it's pretty much already priced in the market, so a quick and decisive war is not going to give us any upside. Will war help us solve some of the underlying economic problems such as overcapacity, poor consumer confidence and possibly inflation with the higher prices of oil?

MARK ZANDI: Well, frankly I think if the war goes well and according to script, the sort of baseline scenario, the most likely scenario, I think there is a lot of upside. I really think the economy is struggling because of the fear of a looming conflict with Iraq. It's clearly affecting investor confidence, business confidence, consumer confidence, and the higher energy prices are having a deleterious effect on all of us. So I think if the war goes well, if it's quick, decisive, and energy prices fall soon thereafter, I think there's quite a bit of upside and I think the economy should do quite well moving in towards the end of the year into next.

GIBBS: Well, do you think the war, the ultimate result will be a stimulus to the economy?

ZANDI: Well, if we get by with the war in easy fashion, and that's pretty much I think sort of the consensus view, and I think that's a reasonable view, yeah, I think there is a lot of upside. In fact, I think growth right now in the economy is arguably 1, 1.5 percent. That's the growth in GDP, the value of all the goods and services that we produce. My guess is that if we hadn't -- if we weren't struggling with these things, if we weren't struggling with the confidence related to the war with Iraq, we'd be growing closer to 3, 3.5 percent. So I think there's considerable upside.

MEYER: I think in the benign case, we felt that that would actually be good for the economy. It's also compared to what? Okay, in the no-war case we have lingering uncertainty. That's weighing on the economy. We're in some sense paying the cost of a possible war with Iraq. If the war is quick and decisive and over, that uncertainty dissipates and you get a bounce back in equity prices, improving the consumer confidence, and the economy moves ahead. So I do think that there's an upside in the benign scenario.

GIBBS: What type of sectors of the economy could benefit from this quick and decisive move? We've been struggling for a while now.

MEYER: Well, I think that on the other side, look, we've had a resilient consumer sector. Housing has been doing well. The real problem here is hesitancy on the part of businesses, the failure of investment to bounce back. And that's what we really sort of look for on the other side of the war, that businesses would sort of come back, begin to invest, begin to hire again, and that would really push the economy from its sort of stagnant, sort of low-trend growth into finally sustainable, above-trend growth.

ZANDI: And I think manufacturers would clearly benefit. Anyone who uses energy intensively would benefit from a quick end to the war and lower energy prices. So all of manufacturing would benefit, and that obviously has been the hardest pressed sector of our economy. Transportation companies, airlines, truckers would all benefit. And of course you and I would benefit, Karen. I mean, I don't know about you, but I filled up my gasoline tank today. I think I paid $1.70 for 87 regular, and I remember a year ago I must have been paying a $1.10, $1.15. That's a big hit, and this is a cold winter out here in the Northeast. You're under 28 inches of snow; I'm under 18. We're heating our homes, and that costs a lot, too. So lower energy prices would go a long way to helping all of us.

GIBBS: Well, let's talk about the problem with oil and how important it is. A lot of people are just thinking that it's Exxon, Mobil and other oil companies that are getting rich. But it also acts -- rising oil prices -- acts as a tax on consumers. Can you explain what that does to us, Mark?

ZANDI: Well, if we have to spend more on filling our gasoline tank, heating our homes, getting electricity, then we have less to spend on everything else. It's exactly like a tax increase, except it's even worse than a tax increase in the sense that when you pay your taxes, presumably it goes to a government that does something good with it. Now, there might be some debate in Washington about the merits of that statement, but I think we all feel that if we give a check to the federal government or our local government it will help in some way increase government spending. But if we give money to pay for gasoline, more money for gasoline or home heating, the energy companies benefit a little bit, but most of the benefit goes overseas to foreign energy producers. And in fact, you know, unless they're shopping at Tiffany's in New York, I'm not sure it helps us much at all.

MEYER: I agree with that entirely, except that's the smaller part of the story. In a situation like this, the increase in the relative price of oil does its normal damage, but the greater damage comes from the increase in risk aversion from the impact on equity prices because of the psychological effects, opening up a risk premium in capital markets, declining consumer confidence, way above the effects that you would attribute to just an increase in the relative price of oil. So all of that is true, but when we did our sort of analysis, we found out that was the smaller part of the damage to the economy. It's proportional in some sense, the increase in oil prices, because it acts as a kind of a proxy for all of those uncertainties and political concerns and concerns about the outcome of the war.

ZANDI: Larry's absolutely right. Confidence is the key element here. In fact, the Philadelphia Fed did a survey of businesses in their sort of region, and they asked, you know, what's the major constraint on your hiring and spending? And 40 percent said it was geopolitical risk, you know, i.e. Iraq. Another 60 percent said weak demand. Well, that also has to be related to Iraq. I mean you and I aren't spending as aggressively as we normally would because we're fearful of Iraq, and of course the equity market's down and that's weighing on us as well. So it's a very significant factor in influencing confidence.

GIBBS: All right. Mark Zandi and Laurence Meyer, we have to leave it at that. Thank you very much for joining us.