How the Iran War Is Making Everything More Expensive

 

By James Secondine

On February 28, 2026, the United States and Israel launched a series of strikes against Iranian defense infrastructure and leadership. Within days, the conflict escalated into a direct confrontation near one of the most important chokepoints in the global economy: the Strait of Hormuz.

Roughly one-fifth of the world’s oil passes through that narrow waterway. As both sides moved to disrupt both physical and perceptive capacity, global oil supply took a hit, and prices started climbing. For consumers already weary of post-pandemic inflation, the timing could not have been worse.

Why Does an Oil Shortage Raise the Price of Everything?

Oil is what economists call a fungible good: one barrel is roughly interchangeable with another, regardless of where it was pumped. That matters here because when Middle Eastern oil disappears from the market, countries don’t simply go without; instead, they bid for supply from elsewhere.

Global demand for oil stays roughly the same while supply shrinks, and prices rise worldwide. The supply shock in the Strait of Hormuz does not just affect the Gulf states’ traditional customers in East Asia and Europe; it also raises energy costs for everyone because oil is fungible and traded on a global market.

What makes oil especially inflationary is how inelastic demand for it is. In plain terms, people and businesses do not cut their oil consumption much even when prices spike. In the short run, consumers are stuck: they still need to commute, heat their homes, and ship goods. Businesses still need fuel to run factories and trucks. There is no quick substitute.

A Federal Reserve analysis of multiple studies found the median short-run price elasticity of oil demand to be just -0.13 (Caldara et al., 2016). An elasticity of -0.13 means a 10% price increase only reduces demand by about 1.3%.

This inelasticity is also why oil shocks are so inflationary. Energy and petroleum byproducts like plastics, chemicals, and industrial lubricants are embedded in the production of many goods and services in a modern economy. When the cost of oil rises, it ripples outward through every stage of production from the factory floor to the shipping dock to the retail shelf. Each layer passes the higher input costs along, and the result is broad-based price increases or cost-push inflation that consumers feel on nearly every receipt.

What Do the Numbers Say So Far?

The inflationary impact has already started showing up in the data. According to the Bureau of Labor Statistics, the Consumer Price Index rose 0.9% in March 2026, followed by 0.6% in April and 0.5% in May, a sharp acceleration from the 0.3% increase in February and just 0.2% in January (BLS, 2026). 

How Are Central Banks Responding?

So far, with caution, major central banks have refrained from raising interest rates in response to the oil shock (Partington, 2026). Their reasoning rests on two points: first, inflation in advanced economies had been cooling before the war began, and second, the duration of the conflict, and therefore the oil disruption, remains deeply uncertain, especially given the unpredictability of U.S. foreign policy under the current administration (Yilek, 2026).

This wait-and-see stance is understandable, but history suggests the window for patience may be closing. When oil prices surged during the 1973 Arab oil embargo, central banks eventually turned to contractionary monetary policy: raising interest rates and selling securities through open market operations to pull money out of the economy and slow inflation. Higher interest rates make borrowing more expensive, which dampens spending and, in theory, cools rising prices.

The Stagflation Trap

The real danger with oil shocks is that they can trigger stagflation, the toxic combination of rising prices and a slowing economy. Oil prices push up inflation, while reduced availability of energy and petroleum-based inputs hampers economic output and raises unemployment.

The above graph illustrates stagflation, a situation where the economy experiences both rising inflation and falling output at the same time. Initially, the economy is in equilibrium at E₁, where the aggregate demand (AD) curve intersects the short-run aggregate supply curve (SRAS₁) and the long-run aggregate supply (LRAS). A negative supply shock, such as higher oil price, shifts the short-run aggregate supply curve leftward from SRAS₁ to SRAS₂. As a result, the equilibrium moves to E₂, where the price level increases while real GDP decreases. This combination of higher inflation and lower economic output is known as stagflation and often presents a challenge for policymakers because measures to reduce inflation may further reduce output, while policies to stimulate growth may increase inflation.

Stagflation puts central banks in an especially difficult position. Institutions like the Federal Reserve operate under a dual mandate: they are tasked with keeping both inflation and unemployment low. But those two goals require contradictory tools. Fighting inflation calls for tighter monetary policy, which risks pushing unemployment even higher. Supporting employment calls for looser policy, which risks letting inflation run hotter. There is no clean answer, only trade-offs.

For now, central banks are betting that the conflict will be short-lived enough to avoid that dilemma. Whether that bet pays off depends on how long the Strait of Hormuz remains disrupted and how quickly the global economy can adapt if it doesn’t reopen soon.

References

Caldara, D., Cavallo, M., & Iacoviello, M. (2016). Oil price elasticities and oil price fluctuations. International Finance Discussion Papers (No. 1173). Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/econresdata/ifdp/2016/files/ifdp1173.pdf

Hoffman, R., Hamilton, J., Mory, J., Mork, K., & Hooker, M. (2012). Estimates of oil price elasticity. International Association for Energy Economics, 19, 19–20.

Mwange, A., & Meyiwa, A. (2022). Monetary policy responses to crude oil-price shocks: The case of selected central banks. Journal of Economics and Business, 5(3). https://doi.org/10.31014/aior.1992.05.03.440

Partington, R. (2026, April 27). G7 central banks poised to hold borrowing costs amid concerns over prolonged Iran war. The Guardian. https://www.theguardian.com/business/2026/apr/27/g7-central-banks-hold-borrowing-costs-global-economy-iran-war-inflation-prices-warning

U.S. Bureau of Labor Statistics. (2026). Consumer Price Index – May 2026.

Yilek, C. (2026, April 30). As Iran war nears key 60-day deadline, Congress and Trump face choices on next steps. CBS News. https://www.cbsnews.com/news/iran-war-powers-resolution-60-day-deadline-congress-trump/

About the Author

James Secondine is an Economics and International Business student studying at Northeastern University. He is passionate about economics and the relationships between nations that drive global trade. For inquiries, queries, or any other matters, he can be reached at secondine.j@northeastern.edu or via LinkedIn: https://www.linkedin.com/in/james-secondine/