The war in Iran has sparked a global energy crisis that has rocked markets and sent oil prices surging to their highest level in four years. The chances of a quick resolution appear to be deteriorating as the conflict escalates, as do hopes that the U.S. economy might escape unscathed.
But that scenario rides on a relatively quick return to pre-war price levels over the next few months. The longer the strait remains closed and the higher prices rise, the faster the economic situation around the world—including in the U.S.—deteriorates.
Oxford Economics uses a standard rule of thumb to estimate the economic impact of pricier oil: Every time oil gets $10 more expensive for a sustained period—determined to be around two months—it amounts to a 0.1% decline in GDP due to higher inflation and slower growth. If prices average $100 for two months, it would erase a few tenths of a percentage point of global GDP growth, but a recession would likely be avoided, according to the report.
The breaking point for the economy, Oxford Economics found, will be if oil prices average around $140 a barrel for two months. At that price, spillover effects would be much harder to contain, and many parts of the world would be flirting with economic decline.
“There are mild contractions in the Eurozone, the UK, and Japan, while the U.S. nears a temporary standstill and layoffs push up the unemployment rate, leaving it close to a recession,” the report’s authors wrote.
The problem with calculating the economic consequences of higher oil prices is that the implications are exponential. The more prices rise, the more knock-on effects could happen to hurt the economy. Higher-for-longer oil and transportation costs would begin to spill over into food and other goods, making inflation an across-the-board problem rather than a primarily fuel and energy-focused one. The Federal Reserve and other central banks would also be more inclined to tighten their interest rate policy if it became clear oil prices would remain high, dampening down economic activity.
The final complication is more psychological. Sustained high oil prices could lead to a “deterioration in the collective psyche,” according to the report, as expectations of high prices become fixed among consumers. And in the car-dependent U.S., where consumers pay particularly close attention to gasoline prices, fuel inflation would risk crowding out households’ disposable income and lower spending elsewhere, also contributing to a slowdown.
