Long Iran war may require painful central bank tightening, IMF chief economist says

By David Lawder

WASHINGTON, April 14 (Reuters) – Central banks may need to inflict much more economic pain to control inflation fueled by a long Middle East war than they did to control the spike in prices after the pandemic, the International Monetary Fund’s chief economist said on Tuesday.

But IMF chief economist Pierre-Olivier Gourinchas said in an interview that the global economy is not facing a 1970s-style bout of wage-price inflation,  as the oil shock will hit a much-smaller share of economic output and central banks have gotten much better at controlling inflationary expectations over the past 50 years.

When Russia’s invasion of Ukraine in 2022 drove oil prices above $100 a barrel, an already overheated post-COVID economy meant small increases in interest rates went a long way to cool demand, Gourinchas said.

But with much more slack in today’s economy, including a weaker labor market and ample supplies of most goods and services, much stronger monetary tightening may be needed, particularly if inflation expectations become unanchored, Gourinchas said.

“Stepping on the brakes will be painful” in such an environment, Gourinchas said as IMF and World Bank spring meetings got under way in Washington. 

“You may have to inflict a lot more pain to get the same disinflation result.”

However, it’s far from clear how hard central banks may need to push back against the effects of rising prices for oil, gas and other commodities considering the uncertainty over how the conflict will develop.     

The IMF on Tuesday cut its 2026 global growth outlook to 3.1%, down 0.2 percentage points from January, based on the assumption the war will be short-lived and oil will average $82 per barrel for the year. But Gourinchas told a news conference that the world was already drifting toward the institution’s “adverse scenario” of a longer conflict and oil prices averaging $100, this year with growth slowing to 2.5%. 

Its “severe scenario” envisions an extended conflict, with oil prices averaging $110 in 2026 and $125 in 2027. Growth drops to 2.0% this year, which the IMF sees as the brink of a global recession. 

The main concern in such an environment is that inflation expectations could become unanchored, Gourinchas said, adding that 2022’s inflation shock had made people hypersensitive to prices.

Companies would raise prices more readily, and workers would be quicker to seek higher pay, he said.

“Once we get into that world, people are going to look at this and say, inflation is here and it’s here to stay.”

He said there are key parallels and differences between now and the 1970s oil shocks. By volume, the current shortfall in oil supplies averaged over 2026 is about the same size relative to global consumption as it was in the 1970s.

“Now the good news is between 1974 and now, the global economy has become much less oil intensive, or fossil fuel intensive more generally. So we produce a lot more GDP per barrel of oil,” he said. “And so the impact on the economy from a shock the same size could be smaller.”

Gourinchas said that central banks in the 1970s were more focused on supporting economic activity than controlling inflation, and since that decade’s oil shock and a crushing early 1980s recession to quell inflation, they have become more independent from governments and developed frameworks for inflation targeting.

“We don’t necessarily think that they need to raise interest rates right away, but if they see signs that inflation is taking hold, that if they see signs that the wage-price spirals, if they see signs that households and businesses start expecting a more permanent and persistent inflation, then they will need to take action,” Gourinchas said.

(Reporting by David Lawder; Editing by Kevin Buckland and Andrea Ricci )