Iran War & Economy: Oil Prices, Inflation & Recession Risks

The “fog of war” – the confusion and uncertainty inherent in conflict – extends to the economic consequences of war, particularly when it impacts regions critical to global energy supplies. As the joint U.S.-Israeli strikes on Iran continue, the potential for significant economic disruption looms large, with Qatar issuing a stark warning on March 6, 2026: “This will bring down the economies of the world,” according to a report by Middle East Eye.

The U.S. Economy was already exhibiting signs of weakness prior to the escalation, with data released on March 6 revealing an unexpected loss of 92,000 jobs in February.

As an economist, I anticipate the most significant economic risks stemming from this conflict will be inflationary pressures and slowing growth, driven by rising oil prices. The uncertainty inherent in this “economic fog of war” could dampen consumer spending and discourage business investment, presenting challenges for policymakers attempting to steer the economy.

Uncertainty and Risks

Currently and likely for some time, there is considerable uncertainty surrounding the duration of the war in Iran, the scope of international involvement, and the overall costs. These factors will ultimately determine the extent of the economic impact, both in the U.S. And globally.

Disruptions to the supply of oil and liquefied natural gas are already materializing, particularly through the Strait of Hormuz, a vital waterway for energy transport. The fiscal costs associated with military action are also mounting.

Since the commencement of U.S. And Israeli bombing campaigns on February 28, the price of crude oil has increased by approximately 25%, contributing to rising gasoline prices across the United States. A substantial portion of Middle Eastern oil and liquefied natural gas transits the Strait of Hormuz, but the threat of attack has rendered the passage uninsurable, effectively halting shipping through this crucial route.

The military campaign is also proving costly for the United States, with losses of aircraft and depletion of missile stocks already reported. Early estimates suggest the war is costing nearly US$1 billion per day, according to the Center for Strategic and International Studies.

Challenges Managing a Supply Shock

The 1979 Iranian Revolution similarly triggered a surge in oil prices, contributing to the economic phenomenon of “stagflation” – a combination of stagnant growth and high inflation – in the United States and Europe.

While a repeat of that scenario is not anticipated to the same extent, due to reduced economic dependence on oil and natural gas compared to the late 1970s and early 1980s, policymakers face difficult choices. The U.S. Is not entering this conflict with the same history of high inflation that complicated efforts to curb price pressures in the past.

However, supply shocks remain challenging to address, as demonstrated by the COVID-19 pandemic, and policymakers will likely need to navigate difficult trade-offs.

Trade-off Between Fighting Inflation or Recession

A central question arising from supply shocks is whether to raise interest rates to combat inflation or lower them to offset economic weakness and rising unemployment. Increasing rates reduces inflation by curbing demand, while lowering rates has the opposite effect.

During both the late 1970s and the onset of the COVID-19 pandemic, the Federal Reserve opted to maintain low rates to support the economy and job market, which ultimately contributed to a surge in inflation.

Inflation in the late 1970s and early 1980s was eventually brought under control through a sharp reversal of monetary policy with high interest rates, resulting in a recession that was, at the time, the deepest since the 1930s. However, the recent reduction in inflation following COVID-19 did not require a comparable economic downturn, largely due to the long-standing anchoring of inflation expectations.

Risks on the Horizon

However, concerns remain. While the Federal Reserve has established a credible anti-inflation stance, its independence is being challenged by President Trump’s criticisms of Chairman Jerome Powell, the prosecution of Federal Reserve Board member Lisa Cook, and the potential appointment of a new chair who may prioritize lower rates at the president’s behest.

Concerns about these actions undermining the Fed’s credibility could become a self-fulfilling prophecy, fueling inflation. The seeds of new inflationary pressures may be taking root.

The uncertainty triggered by the war is not the only economic headwind. Tariff policies, cuts to government employment, rising federal debt, and potential financial vulnerabilities are all weighing on the U.S. Economy. A spike in oil prices could exacerbate these weaknesses, potentially triggering a recession as consumers and businesses curtail spending.