War with Iran delivers another shock to the global economy

The war with Iran is unleashing devastating economic ripple effects globally, destabilizing energy markets, threatening food security, and complicating economic policy decisions across continents.

The conflict has effectively shut down the Strait of Hormuz—a critical maritime passage through which approximately one-fifth of the world’s oil supply flows—following missile strikes by the United States and Israel on February 28 that killed Iranian leader Ayatollah Ali Khamenei.

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

The closure of this vital shipping route has triggered a dramatic surge in oil prices, which jumped from less than $70 per barrel on February 27 to nearly $120 before settling around $90. This spike has driven U.S. gasoline prices up to an average of $3.48 per gallon from just under $3 a week ago, according to AAA.

The impact is being felt more severely in Asia and Europe, which rely more heavily on Middle Eastern energy supplies than the United States. In India, restaurants are warning of potential closures as the government prioritizes household gas supplies. Thailand has suspended overseas travel for civil servants and implemented energy-saving measures, while the Philippines has introduced a temporary four-day workweek for some government agencies. Vietnam is encouraging remote work to reduce energy consumption.

International Monetary Fund Managing Director Kristalina Georgieva warned that each 10% increase in oil prices—if sustained for most of the year—will push global inflation up by 0.4 percentage points and reduce worldwide economic output by up to 0.2%.

“The Strait of Hormuz has to be reopened,” emphasized Simon Johnson, MIT economist and 2024 Nobel economics laureate. “It’s 20 million barrels of oil a day going through there. There’s no excess capacity anywhere in the world that can fill that gap.”

Despite the severity of the situation, some economists express cautious optimism about global economic resilience. “The world economy has shown itself capable of shaking off significant shocks like broad U.S. tariffs, so there is room for optimism that it will prove resilient to the fallout of the war on Iran,” noted Eswar Prasad, professor of trade policy at Cornell University.

However, the duration of the conflict remains a critical unknown factor. “The question is how long is it going to go on?” Johnson asked. The succession of Mojtaba Khamenei, son of the slain ayatollah and believed to be an even more hardline figure, further complicates prospects for resolution. Additionally, Johnson pointed out uncertainty about U.S. objectives: “This is all about President Trump. It’s not clear when he’s going to declare victory.”

The economic impact of the conflict is creating clear winners and losers. Energy importers—including most European nations, South Korea, Taiwan, Japan, India, and China—are suffering from higher prices. Pakistan faces particularly dire circumstances, importing 40% of its energy with heavy reliance on liquified natural gas from Qatar, supplies of which have been disrupted by the conflict.

Conversely, oil-producing countries outside the war zone—such as Norway, Russia, and Canada—stand to benefit from higher oil prices without facing direct military threats.

The crisis extends beyond energy markets. Up to 30% of global fertilizer exports pass through the Strait of Hormuz, including urea, ammonia, phosphates, and sulfur, according to Joseph Glauber of the International Food Policy Research Institute. Disruptions have already affected fertilizer shipments, raising costs for farmers worldwide.

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

The United States, as a net energy exporter, may gain slightly overall from higher oil and gas prices. However, American households are feeling the financial strain at a politically sensitive time ahead of November’s midterm elections. Mark Mathews, chief economist at the National Retail Federation, noted that U.S. households typically spend $2,500 annually on gasoline, and a 20% price increase forces painful budget adjustments.

Analysts at Evercore ISI calculated that if oil prices remain around $100 per barrel, the resulting higher gasoline prices would effectively cancel out the benefits of higher tax refunds from Trump’s 2025 tax cuts for most Americans, with only the top 30% still seeing net gains.

The crisis also presents central banks globally with a difficult dilemma—whether to raise interest rates to combat inflation or cut them to stimulate economic growth. This has intensified debate within the Federal Reserve, where policymakers are already divided between those concerned about a weak job market and those focused on keeping inflation in check.

“Their minds will easily go to the 1970s,” Johnson observed, referencing the oil shocks that central banks initially mishandled, leading to prolonged high inflation. “They thought it was a temporary shock. They thought they could accommodate with lower interest rates, and they ended up regretting that because inflation became much higher.”

He predicted that the energy price increases triggered by the Iran war will “massively intensify the debate inside the Fed” and make U.S. interest rate cuts less likely in the near term.