Oil tankers in the Strait of Hormuz. (Photo by Asghar Besharati/Getty Images)
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Rising oil prices often trigger recession, but high and stable oil prices don’t. This distinction is key to understanding the effects of the current jump in energy costs that resulted from closure of the Strait of Hormuz.
The historical record shows that recessions are quite common after run-ups of oil prices. In some cases, rising oil prices were part of a general inflation which the Federal Reserve (or another country’s central bank) tried to reverse through tighter monetary policy. In other cases, the oil price shock itself triggered the recession. That’s the kind of recession we need to understand in 2026.
Begin by imagining two economies that are similar except for energy prices. They do not trade with one another. In Scarcia, oil prices have been $100 a barrel for several years, with little expectation that they will change. Abundia, however, enjoys cheap energy: oil has sold for $50 a barrel for many years with no expectation of a change. Both places have full employment and low inflation, but there are differences. In Scarcia commuters more often take public transit or drive fuel-efficient cars. They avoid buying energy-intensive goods. Businesses set up their manufacturing processes with a sharp eye on energy costs.
In Abundia, most people drive to work, and they love big trucks and SUVs. They find energy-intensive products to be good value. Companies manufacture with a greater eye on labor costs than energy savings.
The Abundia people enjoy a slightly higher standard of living than in Scarcia, but they have similar inflation and unemployment rates.
Now suppose there is a major change. In Scarcia, new energy resources are discovered and the price of oil drops from $100 to $50. Consumers have more purchasing power, so they spend more, on both energy and non-energy goods and services. Business profits rise because energy costs fall and sales are up. Only a few businesses suffer, primarily those that provide energy-conservation products. Over time, people will adjust their consumer purchases and business production methods to reflect the greater abundance of energy. But right away, most economic activity can continue even stronger than before the new energy came online.
However, a change in Abundia would be different. If their supply of oil were to be disrupted, consumers would have less purchasing power. They would cut back on energy consumption. But that would not be enough to balance household budgets, so they would also cut back spending on discretionary products. Businesses that had been profitable might sustain losses due to higher energy costs. They would also be hurt by consumers cutting back their spending on non-energy products. Abundia would go into recession.
Over time, Abundia would adjust to the scarcity of energy. Consumers would shift their purchasing to less energy-intensive products. Some of them might not realize that they are conserving on energy; they are simply looking at prices and judging value. The businesses that could not survive at higher energy prices would shut down. Their workers would find jobs elsewhere, though at lower wages.
Eventually, Abundia will have made all of the necessary adjustments. Oil prices will be high but stable, so inflation (the rate of change of the average price level) will drop. Although the rate of price changes will drop, prices will not fall to their old level. Employment will grow in some industries that can use labor to reduce energy usage. Unemployment will again be low, though the purchasing power of wages will be less than in the old days.
These hypothetical worlds tell us how the closure of the Strait of Hormuz will impact the global economy. We are transitioning from Abundia into Scarcia. In the short run, total economic activity will contract across a wide range of sectors, and this period of weakness will last for months. That’s the definition of recession.
With these hypothetical economies in mind, we can better understand our actual world. If the Strait of Hormuz continues to be closed for another month or more, the world economy—including the United States—will look like Abundia in recession. Patterns of economic activity that made sense with $60 oil will have to change. People will lose jobs.
Our economy will have another problem that was not anticipated in the hypothetical story above: uncertainty about the future. Should people make permanent changes in their behavior? Should they buy more fuel-efficient cars, or sell their cars altogether? Should businesses discontinue energy-intensive products and scrap energy-intensive production equipment? Or will oil prices soon return to their old level? Anyone who thinks the answer will come from an economist should consider this: I don’t have a clue what the outlook is for peace in the Persian Gulf.
We can be confident, though, that a recession would be temporary rather than permanent. People and businesses will adjust to the new conditions. After the adjustment, we can have full employment and whatever inflation rate the Fed has the will to bring about.
Recessions are about adjustments. A major change in the availability of a key resource will necessitate significant adjustments to spending and production patterns. But the period of adjustment will eventually be over, and with that the recession will end.