The conflict in Iran is driving the US economy closer to a period of 'stagflation'

Main Points

• Experts warn that ongoing conflict in Iran is heightening threats to both inflation and employment, as energy supply disruptions continue.

• While there are similarities to the oil crisis of the 1970s that triggered stagflation, important differences exist between then and now.

• Economists suggest that the economic impact on prices and growth could diminish if the conflict is resolved swiftly.

With turmoil in the Middle East, escalating oil costs, and a sluggish job market, the current economic climate is drawing comparisons to the 1970s.

The economic outlook deteriorated over the weekend as military actions by the U.S. and Israel against Iran persisted. Iran’s near-closure of the Strait of Hormuz has restricted about one-fifth of global oil shipments. Concerns are mounting that the conflict and its effects on energy supplies could persist, as neither side appears willing to de-escalate.

Potential for Stagflation

The possibility of a drawn-out war has increased the risk that the U.S. could face a period of elevated inflation combined with weak economic growth, known as stagflation. The last significant episode of stagflation occurred in the 1970s under similar circumstances, when conflict involving the U.S. and Iran sent energy prices soaring. Economists note that whether stagflation returns depends largely on how long the current hostilities last.

“The U.S. economy is now experiencing its second stagflation-type shock in less than a year,” wrote Sal Guatieri, senior economist at BMO Capital Markets. “Following the trade war, the Iran conflict is set to push inflation and bond yields higher, disrupt energy supply chains, undermine business and investor confidence, and dampen global demand.”

Economic Consequences

Stagflation erodes consumers’ quality of life by weakening the labor market, which reduces incomes, and by driving up prices, which diminishes the purchasing power of the dollar.

Analysts anticipate that the conflict will both push prices higher and further strain a job market that was already faltering and lost 92,000 jobs in February before the war began. With oil prices rising, Pantheon Macroeconomics forecasts that the national average price for a gallon of gasoline could climb from $3 to $4.

“Drivers will soon be paying $4 per gallon for gasoline, which will squeeze real disposable income and negatively affect employment,” commented Samuel Tombs, chief U.S. economist at Pantheon.

Deutsche Bank economists point out several distinctions between today’s situation and the 1970s, when inflation surged into double digits, gasoline was rationed, and the economy endured multiple recessions.

For example, the U.S. is now a leading oil producer, and consumer expectations for future price increases are lower, reducing the likelihood of a wage-price spiral that could accelerate inflation.

How Long Will the Impact Last?

“Ultimately, whether history repeats itself depends on the duration of this conflict,” wrote Jim Reid, global head of macro research at Deutsche Bank.

Mounting risks to prices and employment could leave the Federal Reserve in a difficult position as it seeks to balance its dual mandate of maintaining low inflation and unemployment. Even before the war, Fed policymakers were split on whether to keep interest rates elevated to combat inflation or lower them to support job growth.

“Some officials may advocate for overlooking a supply shock to support a weakening labor market, while others may caution against repeating past errors by easing policy too soon,” wrote Daniella Hathorn, senior market analyst at Capital.com. “The likely outcome? A more divided Fed, increased uncertainty in policy, and greater volatility in both bond and equity markets.”

Perspectives and Outlook

President Donald Trump appeared unfazed by the surge in oil prices, stating on social media, “Short-term oil prices, which will drop rapidly when the destruction of the Iran nuclear threat is over, is a very small price to pay for U.S.A., and World, Safety and Peace. ONLY FOOLS WOULD THINK DIFFERENTLY!”

Some economists believe a return to stability is possible—if the conflict is resolved soon. Reid observed that oil markets are not anticipating a prolonged shock, with oil futures for the next year trading at $75 per barrel.

Forecasters at Oxford Economics have not changed their outlook for interest rates or equities, predicting that the S&P 500 will recover its recent losses once the conflict ends.

“Assuming the military campaign remains limited, the effect on U.S. GDP and inflation should be relatively minor,” wrote John Canavan, lead analyst at Oxford Economics.