Whether Trump decides to retreat or doubles down on the Iran war, the global economy is heading for the double-headed python of stagflation.
Michael Roberts is an Economist in the City of London and a prolific blogger.
Cross-posted from Michael Roberts’ blog
In its latest review of the impact of the Middle East conflict on the world’s economies, the IMF summed it up: “Although the war could shape the global economy in different ways, all roads lead to higher prices and slower growth.”
The global benchmark oil price is on course for its largest monthly rise on record in March, higher than in 1990 when Iraq invaded Kuwait. The conflict could end soon, as Trump and Rubio claim (presumably through with a deal with Iran in which the latter basically surrenders to US demands). Or more likely there is a longer conflict stretching out into April and beyond, possibly involving US troops on the ground attempting to break Iran’s stranglehold over the Strait of Hormuz and searching for its nuclear stockpiles.
Either way, crude oil prices will stay high for some time (and even more for prices of oil derived products, which have risen even more).
That means two things. In the short term, global inflation is going to rise. If the conflict lasts longer, then rising inflation will be joined by falling economic growth and the likelihood that even some of the major economies could slip into a slump. Stagflation is certain and slumpflation is possible.
If oil and gas installations are permanently damaged or out of operation for a long time, then oil prices will rise further to reach $150/barrel—nearly three times pre-war levels—and natural gas prices would rocket to €120 MWh, or four times the pre-war rate. Such a rise would be comparable to the global supply shock of the late 1970s, which contributed to high inflation and global recession. France’s Finance Minister Roland Lescure reckons that 30–40% of Gulf refining capacity has already been damaged or destroyed by Iran’s retaliatory strikes, leaving a shortage of 11 million barrels a day on global oil markets. Lescure warned it could take up to three years to restore damaged facilities and several months to restart those that were urgently shut down.
Goldman Sachs economists offer three scenarios: the baseline scenario is six weeks disruption where crude oil price rises to $120/barrel before falling back to $80–100, with no lasting infrastructure damage. The second scenario is a medium-term war (ten weeks) where the crude price spikes to $140/barrel, staying at $95+ for a further ten weeks. This would “scar” production permanently. The third scenario is apocalyptic (with ten weeks of war and lasting damage). Then the oil price rises to $160/barrel and never falls back below $100 for the foreseeable future because of damage to production facilities.
The OECD’s latest economic outlook has already downgraded forecasts for real GDP growth in the major economies this year due to the US-Israel war with Iran. All G7 economies except the US will now grow more slowly this year than previously forecast, with the UK reduced the most—from 1.2% to just 0.7%. The US economy will grow faster than forecast, according to the OECD, because of gains for its oil and gas exports. The OECD has also raised its forecast for inflation in the top G20 economies from a previous 2.8% to 4%. Argentina will have the highest rate of inflation in the G20 at 31% and China the lowest at 1.3%. US inflation will jump to 4.2% from the current 2.9%. If the war continues into the next quarter, expect these growth forecasts to be further reduced and inflation forecasts raised.
Revised OECD growth forecasts
In my view, contrary to the OECD’s optimistic forecasts on US growth, the US will not escape this downturn. According to Royal Bank of Canada economists, if oil prices hold at $100/barrel, it could cut US real GDP growth by 0.8 percentage points (from the current average 2% a year to near 1%) and US inflation could reach 4% a year.
The World Trade Organization (WTO) forecasts that if energy prices remain persistently high, merchandise trade growth this year will slow from 1.9% to 1.5%. North American export growth will slow a bit, from an expansion of 1.4% to 1.1%, but Europe will be clobbered, with exports shrinking by 0.6% rather than growing by 0.5%. The hit to growth will be equally lopsided: while costly energy could boost GDP growth in North America this year to 2.5% (from a baseline of 2.3%), it would slow GDP growth in Asia to 3.1% from 3.9%. In Europe, a long war would bring the economy almost to a halt, slowing its expansion to 0.4% from a prior estimate of 1.6%. Analysis by the ECB also reckons that a long war would mean a deep, prolonged downturn in output with persistently higher inflation.
The World Trade Organization (WTO) forecasts that if energy prices remain persistently high, merchandise trade growth this year will slow from 1.9% to 1.5%. North American export growth will slow a bit, from an expansion of 1.4% to 1.1%, but Europe will be clobbered, with exports shrinking by 0.6% rather than growing by 0.5%. The hit to growth will be equally lopsided: while costly energy could boost GDP growth in North America this year to 2.5% (from a baseline of 2.3%), it would slow GDP growth in Asia to 3.1% from 3.9%.
In Europe, a long war would bring the economy almost to a halt, slowing its expansion to 0.4% from a prior estimate of 1.6%. Analysis by the ECB also reckoned that a long war would mean a deep, prolonged downturn in output with persistently higher inflation. Already, Euro area annual inflation climbed to 2.5% in March, up from 1.9% in February.This marked the highest rate since January 2025, pushing inflation above the ECB’s 2% target as energy costs soared 4.9%, the first annual increase in nearly a year and the sharpest since February 2023, driven by the Middle East conflict.
Moreover, an energy price explosion does not just drive up overall inflation, at a certain point, it forces households and businesses to cut back on purchases and investments in order to meet energy bills. It becomes a tax on growth. Already, borrowing costs, as expressed in long-term government bond yields, are rising in all the major economies.
How high and for how long must energy (and other key commodity prices) rise for a slump to happen? There are various estimates. Paul Krugman, the Keynesian economist, reckons that the price elasticity of demand for crude oil is low — that is, even large price increases only cause small declines in demand (ie GDP). But this time could be different. He reckons that ‘low disruption’ (oil price $100-150/b) would reduce supply by about 8% in the US. Medium disruption (oil price $120-230/b) would cause a fall of 12% in US economic growth. High disruption (oil price $155-370/b) would take US supply down 16%.
A prolonged conflict would hit the Middle East and Asia hardest. The Gulf states would lose their lucrative tourist traffic and airlines may be forced to bypass the area for global transit. The heady days of luxury lifestyles for foreigners would be over in these places. With large infrastructure projects in Gulf countries targeted by strikes, migrant construction workers will have less money to send home—a loss affecting households across the Middle East and South Asia. Workers in Gulf countries send home $88 billion in remittances annually. Countries such as Egypt, Pakistan, and India are the biggest recipients, amounting to tens of billions of dollars per year and accounting for more than half of all remittances received in these economies. Egypt, Pakistan, and Jordan each receive more than 4% of GDP from Gulf remittances.
Société Générale estimates that every $10 sustained increase in oil prices would widen India’s current account deficit—currently around 1% of GDP—by half a percentage point and would cut economic growth by 0.3%. At $100/barrel, that would mean a current deficit of 3% of GDP and a reduction in economic growth from a 2026 forecast of 6.4% to 5%. The Centre for Global Development (CGD), a Washington-based organisation, compiled a list of 17 countries most vulnerable to the shocks of the Iran war. Thirteen of those are African, including Angola, Nigeria, Egypt, Ghana and Ethiopia. In Asia, Pakistan, Bangladesh and Sri Lanka were deemed vulnerable, with Jordan singled out in the Middle East.
Taken together, higher oil prices and exchange rate devaluation will lead to a negative terms-of-trade shock for many countries, making it harder to service external debt and build foreign exchange reserves. Countries that have both high external debt service and low reserves will be especially at risk. For instance, Egypt may need to roll over more than $4 billion in outstanding eurobonds in the next year; Jordan and Pakistan may need to roll over around $1 billion apiece.
About 70% of Brazil’s and 40% of India’s urea imports—essential to their agriculture sector—come from the Gulf through the Strait of Hormuz. Gulf nations import most of their food: 75% of their rice comes through the strait, as well as more than 90% of their corn, soybeans and vegetable oil.¹² On top of all this, countries like Bangladesh, India and Pakistan will be hit by the inevitable drop in remittances from millions of their citizens working in Gulf countries as the war takes a toll on the regional economy.
Three countries will be less affected. The US has plenty of strategic stockpiles and, of course, its own domestic production. Although China relies for much of its oil from the Middle East (mainly Saudi Arabia), it has been building up its strategic stockpiles for just such events and because of worries about US sanctions. Last year, China imported about half of its crude oil and almost one-third of its liquefied natural gas from the Middle East. But it has aggressively built up strategic stockpiles of fossil fuels. China is estimated to hold the world’s largest emergency reserves of petroleum, totalling 1.3 billion barrels.
China has also made significant investments in electrification. Electricity accounts for 30% of the country’s energy consumption—about 50% higher than the US or Europe—making it more insulated from rising global oil prices. (With its rapid solar and wind build-out, it already accounts for roughly one-third of renewable energy generation capacity worldwide.) A diverse energy mix, multiple suppliers and access to routes that bypass the Gulf mean only about 6% of China’s total energy consumption is directly exposed to disruptions in the strait, estimates Goldman Sachs.
So China is well placed to deal with any shortages; and it can still turn to more oil imports from Russia and from South America, where it has been increasing supply in recent years to avoid the Middle East. And ironically, Russia will benefit from increased revenues from its energy exports.
One recent study of all wars since 1870 found that: “output falls by almost 10 percent in the war-site economy, while consumer prices rise by some 20 percent (relative to prewar trends).” And “the economies of belligerent countries and even those of third countries witness similarly unfavourable dynamics if they are exposed to the war site through trade linkages.” Output in close trading partners falls by 2 percent relative to trend. This war will easily surpass these averages if it continues much longer.
Easter week is shaping up as a crucial turning point in the war. Will a deal be reached or will the US launch a new stage in the conflict with ground troops? Either way, what is certain is that all roads lead to stagflation.
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