Inflation after the Iran war

Ricardo Reis

No 21751, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: An unexpected increase in energy costs raises inflation directly through flexibly-set prices. Whether that shock amplifies to a larger and persistent rise in inflation depends on its transmission through the economy. This paper examines four channels of transmission of the Iran conflict to inflation in the EA, UK, and the US. The first is the transmission to the sticky prices in core sectors. Recent advances in menu cost models predict that inflation will rise faster than usual and monetary policy is less powerful to curb it. The second is transmission to spending, wages, and nominal returns through higher expected inflation. The empirical literature on household and firm inflation expectations points to some evidence for this amplification. The third channel is through other aggregate demand policies, especially fiscal policy. The IMF reassessments of the fiscal outlook provide some guarded grounds for optimism. The fourth mechanism is through an erosion in the credibility of the long-run inflation target. Data from market prices indicates that the inflation anchor has not moved. All combined, the data as of May 2026 suggests that the Iran war shock will have a significant impact on inflation that persists into 2027, but that is smaller and more short-lived than the 2021--24 inflation disaster.

JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Date: 2026-07
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