The Iran war generates another shock to the global economy

WASHINGTON (AP) — The war with Iran is causing collateral damage to the world economy.

The conflict is driving up energy and fertilizer prices; threat of food shortages in poor countries; destabilize fragile states like Pakistan; and complicating the options for those fighting inflation at central banks like the Federal Reserve.

Causing much of the pain: The Strait of Hormuz, through which a fifth of the world’s oil passes, was effectively closed after the United States and Israel launched missile strikes on February 28 that killed Iranian leader Ayatollah Ali Khamenei.

Bing Guan/Bloomberg via Getty Images

“For a long time, the nightmare scenario that deterred the United States from even thinking about an attack on Iran and that led them to urge restraint against Israel was that the Iranians would close the Strait of Hormuz,” said Maurice Obstfeld, a senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund. “Now we are in the nightmare scenario.”

With a key shipping route cut off, oil prices have soared: from below $70 a barrel on Feb. 27 to a high of nearly $120 early Monday before stabilizing closer to $90. They have taken gasoline prices with them.

According to AAA, the average price of U.S. gasoline has skyrocketed to $3.48 a gallon from just under $3 a week ago. Prices could be felt even more significantly in Asia and Europe, which are more dependent on Middle Eastern oil and gas than the United States.

20 million barrels of oil are lost per day

Every 10% rise in oil prices (provided they persist for most of the year) will increase global inflation by 0.4 percentage points and reduce global economic output by up to 0.2%, said Kristalina Georgieva, managing director of the International Monetary Fund.

“The Strait of Hormuz must be reopened,” said economist Simon Johnson, of the Massachusetts Institute of Technology and winner of the Nobel Prize in Economics in 2024. “20 million barrels of oil pass through there a day. There is no excess capacity anywhere in the world that can fill that gap.”

The global economy has shown it can take a hit, absorbing blows from Russia’s invasion of Ukraine four years ago and President Donald Trump’s massive, unpredictable tariffs in 2025.

Many economists express hope that global trade could falter during the latest crisis.

“The global economy has proven capable of shrugging off major shocks like broad U.S. tariffs, so there is room for optimism that it will prove resilient to the fallout from the war with Iran,” said Eswar Prasad, a professor of trade policy at Cornell University.

Timing is everything

Especially if oil prices can fall back to the $70 to $80 per barrel range, wrote economist Neil Shearing of Capital Economics, “the global economy can absorb the shock with less disruption than many fear.”

But many questions remain.

“The question is how long is it going to last?” said Johnson, also a former IMF chief economist. “It is difficult to see Iran retreat now that it has announced this new leader” – Mojtaba Khamanei. The slain ayatollah’s son is believed to be even more uncompromising than his father.

AP Photo/Vahid Salemi

Also clouding prospects for an end to the crisis is uncertainty about what the United States is trying to achieve. “This is all about President Trump,” Johnson said. “It is not clear when he will declare victory.”

Economic winners and losers

For now, the war is likely to create economic winners and losers.

Energy importers – most of Europe, South Korea, Taiwan, Japan, India and China – will be hit by higher prices, Shearing wrote in a commentary for London’s Chatham House think tank.

Pakistan is in a particularly bleak situation. The South Asian country imports 40% of its energy and is especially dependent on liquefied natural gas from Qatar, whose supply has been cut off by the conflict. Higher energy prices will squeeze Pakistani families and hurt their economy.

However, far from cutting interest rates to provide some relief, the country’s central bank will probably have to raise them, say economists Gareth Leather and Mark Williams of Capital Economics. This is partly because inflation remains uncomfortably high in Pakistan and higher energy prices threaten to make it worse.

But oil-producing countries outside the war zone (Norway, Russia, Canada) will benefit from high oil prices without the risk of missile and drone attacks.

Energy is not the only problem. According to Joseph Glauber of the International Food Policy Research Institute, up to 30% of global fertilizer exports (including urea, ammonia, phosphates and sulfur) pass through the Strait of Hormuz.

The disruption in the Strait has already cut fertilizer shipments, raising costs for farmers and is likely driving up food prices.

“Any country with significant agricultural sectors, including the United States, would be vulnerable,” Obstfeld said. “The effects are going to be most devastating in low-income countries where agricultural productivity may already be threatened. Add this additional cost component and you have the prospect of significant food shortages.”

Where things are in the US

The United States, now a net energy exporter, should gain slightly overall thanks to rising oil and gas prices. But ordinary families will feel the pain at a time when Americans are already furious about high costs ahead of November’s midterm elections.

American households pay $2,500 a year, or nearly $50 a week, to fill up the gas tank of their cars, said Mark Mathews, chief economist at the National Retail Federation. A 20% increase in gas prices means an extra $10 a week out of their budgets, forcing them to cut back elsewhere. “If I have to pay more for something essential, then I would reduce a discretionary item,” Mathews said.

If oil prices remain around $100 a barrel, Evercore ISI analysts calculated, the resulting higher gasoline prices will negate for most Americans the benefits of larger tax refunds this year from Trump’s 2025 tax cuts. Only the top 30% would still see a gain.

A dilemma for central banks

The Iran crisis also puts the world’s central banks in trouble. Higher energy prices fuel inflation. But they also damage the economy. So should central bankers raise rates to curb inflation, or cut them to boost the economy?

The Federal Reserve is already divided between policymakers who think a weak U.S. labor market needs help from lower rates and those who still fear inflation remains stuck above the central bank’s 2% target.

“Their minds will easily go back to the 1970s,” Johnson said, when conflict in the Middle East and an Arab oil embargo sent oil prices soaring. Central bankers are haunted by the memory that their predecessors “didn’t get it right in the 1970s. They thought it was a temporary shock. They thought they could adapt to lower interest rates, and they ended up regretting it because inflation went up so much.”

Johnson predicted that higher energy prices caused by the war with Iran will “massively intensify the debate within the Federal Reserve” and make U.S. rate cuts less likely.

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AP Retail Writer Anne D’Innocenzio in New York and AP Economics Writer Christopher Rugaber in Washington contributed to this report.