U.S.-Iran Resolution Remains Challenging to Handicap

The evolution of oil and the economy

Surging oil prices driven by negative supply shocks can create a challenging outlook for global growth, particularly in the scenario of a protracted Middle East conflict.

In addition to the major supply shocks of the 1970s — the Arab oil embargo of 1973 and the Iranian revolution in 1979 — oil markets were also disrupted by the Iran-Iraq War in the 1980s, the Persian Gulf War following Iraq’s invasion of Kuwait in 1990, and sanctions following Russia’s invasion of Ukraine in 2022.

The 1973 oil embargo had particularly negative outcomes. The U.S. experienced a deep recession, the UK restricted business energy consumption to three days per week at the start of 1974, Japan’s real GDP declined for the first time since the end of World War II, and West Germany’s unemployment rate rose from 1.0% in 1972 to 3.2% at the end of 1974.

However, these historical episodes occurred in a macroeconomic environment that differed meaningfully from today. In the early 1970s, many advanced economies were already experiencing elevated inflation before the oil shock arrived. Wage indexation was common, central bank credibility was weaker, and monetary policy frameworks were less focused on inflation targeting. As a result, higher oil prices fed quickly into broader inflation pressures, reinforcing a wage-price spiral and forcing central banks to tighten policy sharply once inflation accelerated.

Additionally, economies were significantly more energy intensive than they are today. Manufacturing and heavy industry represented a larger share of economic activity, while energy efficiency was lower across transportation, industry, and residential consumption. As a result, oil price increases transmitted more directly into production costs, consumer prices, and economic activity.

While the jump in oil prices following the latest conflict in the Middle East raises downside risks to global growth, there are important differences between the environment today versus that of 50 years ago.

First, global growth is less dependent on oil as economies shifted to being oriented more toward the provision of services rather than the production of goods, and as manufacturing became more energy efficient. We calculate that for every metric ton of oil consumed globally, the world created approximately $21,100 of real GDP in 2024 versus $8,900 in 1980 (in constant U.S. dollars).

This is similar to the work published by Columbia University’s Center on Global Energy Policy², which noted: “The efficiency of oil use has improved, in other words oil intensity has declined, over the years and decades. In 1973, for example, when oil intensity was at its zenith, the world used a little less than one barrel of oil to produce $1,000 worth of GDP (2015 prices). By 2019 (the last data set before Covid) global oil intensity was 0.43 barrel per $1,000 of global GDP—a 56% decline. Oil has become a lot less important and humanity has become more efficient in making use of it.”

Second, the 1970s oil crises provided a catalyst for the creation of strategic petroleum reserves. The International Energy Agency was founded in 1974 to help coordinate a global response to future oil market shocks, including holding reserves of oil. The U.S established its Strategic Petroleum Reserve in 1975, and the 2000s saw the emergence of petroleum reserves in China and India. During the oil embargo of 1973, only a handful of countries had emergency response measures in place for oil supply disruptions. Using consumption levels at the time, readily available oil would last 61 days, assuming no further production. Today, 60 countries have implemented response measures, and oil reserves would last 85 days at current consumption levels.

Bottom Line: The current Middle East crisis likely raises the risk of a larger disruption to the global oil supply than previous negative supply shocks. While stagflation risks have increased, global growth is less dependent on oil than during prior supply shock episodes, and strategic petroleum reserves provide an additional buffer. The ultimate economic impact will depend on the duration and scale of supply disruptions.

Central bank meetings amid rising oil prices and a weaker U.S. jobs report

If Middle East tensions push global economics toward stagflation, central banks would face a difficult policy environment. Most central banks focus primarily on maintaining price stability, and policymakers often attempt to ‘look through’ temporary energy prices shocks.

However, many central banks shifted toward easier policy from 2024–25. History suggests that policymakers must remain cautious. Many economists view the accommodative response to the oil shocks of the 1970s as a key driver of the inflation surge that followed.

If stagflation pressures emerge, we do not expect central banks to respond with additional monetary easing. However, prior policy easing may increase the risk that higher energy costs feed more broadly into inflation.

The challenge with stagflation is that it complicates policy decisions because central banks must weigh inflation risks against slowing economic growth. The Federal Reserve has an explicit mandate to seek maximum employment. Last week’s U.S. employment report for February might challenge the assessment of some Fed officials that the labor market has stabilized.

However, we must be careful not to read too much into any single economic data report. The weakness in the February employment report—including a 92,000 decline in nonfarm payrolls and a rise in the unemployment rate to 4.4% from 4.3%—was not corroborated by other labor market data. For example, initial claims for unemployment benefits were little changed in February at a historically low level, which suggests that layoffs remained subdued. The Institute for Supply Management (ISM) manufacturing and services employment indexes rose in February to the highest level in about a year. The Conference Board’s survey featured a strengthening in consumers’ assessment of the labor market in February. Nonetheless, the stability of the labor market is less certain following the February employment report, and the economy now faces a headwind from higher oil prices.

Bottom Line: Rising oil prices create a difficult policy backdrop for global central banks. Stagflation is not our baseline view. However, lower oil intensity in the global economy, prior policy easing, and inflation still above many central bank targets may encourage policymakers to focus more on inflation risks than on potential growth weakness.