Drawing on our recent research (Kilian et al. 2026a), in this column we assess the inflationary impact of the oil price fluctuations caused by the 2026 Iran War, given the latest data and developments. There is a wide range of views about the extent and persistence of the shortfall of oil exports caused by this event. We quantify the response of US inflation and inflation expectations under a range of scenarios that policymakers and market participants are likely to be concerned with. How relevant each of these scenarios is may change as the geopolitical situation in the Middle East evolves. 

Challenges in assessing the inflationary impact 

The first challenge in addressing this question is how to determine the path of the oil price in 2026 and beyond. To date, attempts to answer this question have mainly relied on simple rules of thumb lacking formal justification, judgemental forecasts, or back-of-the-envelope calculations. For example, Krugman (2026) argues that the price of oil will reach between $155 and $372 per barrel in response to a 16% disruption of global oil supplies, given a global price elasticity of oil demand between 0.2 and 0.1. Such back-of-the-envelope calculations ignore the general equilibrium effects on the oil price. 

Some observers have instead pointed to the term structure of oil futures prices, which shows a meaningful decline in prices in 2026 and 2027, as evidence that the worst is likely behind us. However, not only have daily oil futures prices been erratic, but futures prices represent the price at which firms can hedge, not the price market participants expect to hold in the future (Baumeister and Kilian 2018).

We address this challenge by simulating the path of the oil price under various scenarios for the nature of the geopolitical oil supply shortfall, drawing on a calibrated nonlinear dynamic stochastic general equilibrium (DSGE) model of the global economy recently developed by Kilian et al. (2026b). This model features risk-averse agents, low substitutability between capital and oil, oil storage, and downside risk to oil production and can replicate the key features of global oil market data.

This raises the question of how to map the simulated oil price paths from the quarterly DSGE model into real world data. This is not straightforward because the war broke out in the last month of the first quarter of 2026. We address this challenge by drawing on recently developed structural vector autoregressive (VAR) models of the transmission of monthly gasoline price shocks to inflation and inflation expectations (e.g. Kilian and Zhou 2022).  

This structural VAR approach focuses on the price of gasoline rather than the price of oil because the relationship between oil prices and inflation has been shown to be unstable over time, reflecting changes in the cost share of crude oil in the retail price of gasoline. This problem can be avoided by directly focusing on gasoline prices. The use of a monthly VAR model also avoids having to extend the DSGE model of the global economy to a multi-country setting that includes domestic US inflation. Such an extension not only would be challenging, but would also require taking a stand on nominal frictions, monetary policy, and feedback from the rest of the world. 

Since the VAR model is monthly, we start by mapping the path of the global price of oil in the DSGE model into a path for the West Texas Intermediate (WTI) price of oil. We then interpolate the quarterly WTI price to monthly frequency taking account of the actual evolution of the WTI price in March 2026. Finally, we derive the corresponding path of the retail price of motor gasoline in the United States based on the latest data for the cost share of crude oil in the retail price of gasoline. 

Given this path, we can recursively infer the magnitude of future gasoline price shocks required for the growth rate of the gasoline price to match its targeted value. Feeding this shock sequence into the VAR model allows us to simulate the evolution of the monthly inflation variables starting in March 2026 and to map the results into calendar quarters, facilitating policy analysis. While our analysis focuses on the U.S., it could be extended to other economies by expressing the global price of oil in domestic currency units and estimating a similar structural VAR model on domestic data.

A cautiously optimistic scenario

A complete cessation of oil exports from the Persian Gulf, including a closure of the Strait of Hormuz, would correspond to a disruption of 20% of global oil supplies, defined to include both crude oil and oil products. A plausible scenario – as of late April 2026 – involves a 15% shortfall, equivalent to 15 million barrels per day (mb/d). This takes account of the diversion of some oil exports to ports outside of the Persian Gulf, but assumes that the Strait of Hormuz is closed to all oil traffic, including Iranian oil, given the US blockade of the Gulf of Oman. 

In this scenario, we assume that the closure of the Strait of Hormuz lasts for one quarter, after which there is uncertainty about when oil supplies will return to normal. This is equivalent to expecting the shortfall of oil supplies to gradually decline over time following the one-quarter closure. In line with historical precedent, households and firms expect the closure to last for three quarters. This implies that that, on average, about 60% of the 15 mb/d of remains unavailable one quarter after the Strait reopens, 38% after two quarters, and 22% after three quarters. The gradual increase in expected oil exports allows for frictions in, for example, shipping markets, delays in mine clearing, and repairs to oil infrastructure. We also report analogous results involving a closure of the Strait lasting two or three quarters.  

Given a one-quarter closure of the Strait of Hormuz, our model predicts that the monthly average price of WTI crude oil would peak at $94 per barrel in April and May 2026 and remain above $80 per barrel throughout 2026 (Figure 1, black-dashed line). The longer the Strait remains closed, the more the price of oil rises.

Figure 1 Implied path of the monthly WTI price 

Source: Authors’ calculations based on Kilian et al. (2026a). 
Note: Vertical line marks February 2026. 

The sharp increase in the WTI price causes headline PCE inflation to rise by 1.7 percentage points at an annualised rate in first quarter 2026. Assuming a one-quarter closure, headline inflation remains elevated through third quarter 2026. This lifts Q4/Q4 headline inflation by 0.6 percentage points in 2026 (Table 1, left panel). 

Table 1 Impact of 15% oil supply shortfall with an expectation of a gradual recovery

Source: Authors’ calculations based on Kilian et al. (2026a). 
Note: Quarterly inflation rates are annualised. The resumption of oil exports is expected to be gradual after the closure of the Strait of Hormuz ends.

There are also meaningful effects on inflation excluding food and energy (commonly referred to as core inflation). While the impact on core inflation is muted in first quarter 2026, it increases by 0.4 percentage points in the second quarter, followed by smaller increases later in the year. This translates to a 0.2 percentage point increase in Q4/Q4 core inflation in 2026.

An obvious concern is that the Strait of Hormuz may remain closed for longer, as negotiations continue or the war resumes. Table 1 shows that in the case of a closure that lasts for three quarters, for example, Q4/Q4 headline inflation would increase by 1.1 percentage points and core inflation by 0.3 percentage points.

Immediate resumption of oil exports

The results so far assume that the resumption of oil exports after one, two or three quarters is expected to be gradual, reflecting the distribution of possible outcomes in the model. Alternatively, one could postulate that oil exports resume immediately and fully after the Strait reopens. While this appears unlikely, it provides a useful benchmark. As Table 2 shows, in this case the increases in Q4/Q4 headline and core inflation are reduced to 0.2 and 0.1 percentage points, respectively. Table 2 suggests one has to be confident about a quick resolution of the conflict to be able to support lower estimates of the inflationary impact than in Table 1.

Table 2 Impact of 15% oil supply shortfall with an immediate recovery

Source: Authors’ calculations based on Kilian et al. (2026a). 
Note: Quarterly inflation rates are annualized. Oil exports are assumed to resume immediately and fully after the closure of the Strait of Hormuz ends.

Widening of the war

Another concern is that a resumption of military action could easily end the diversion of oil exports to ports outside of the Persian Gulf, as Iran or its proxies attack oil infrastructure and shipping routes. This would raise the shortfall to 20% of global oil supplies. In this case, the WTI price would gradually rise to $167 and Q4/Q4 headline inflation could increase as much as 1.8 percentage points and core inflation as much as 0.4 percentage points, if the closure persists for three quarters (Table 3).

Table 3 Impact of 20% oil supply shortfall with an expectation of a gradual recovery

Source: Authors’ calculations based on Kilian et al. (2026a). 
Note: Quarterly inflation rates are annualised. The resumption of oil exports is expected to be gradual after the closure of the Strait of Hormuz ends.

While our focus has been the impact of the 2026 Iran War, the same approach could be applied to similar crises in the future. This is particularly important given that geopolitical oil supply disruptions have been a recurrent phenomenon since the 1970s.

Authors’ note: The views expressed in this column are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.

References

Baumeister, C and L Kilian (2018), “A general approach to recovering market expectations from futures prices with an application to crude oil,” manuscript, University of Michigan.

Kilian, L, M D Plante, A W Richter and X Zhou (2026a), “The Impact of the 2026 Iran War on U.S. Inflation: A Scenario Analysis,” CEPR Discussion Paper No. 21373. 

Kilian, L, M Plante and A Richter (2026b), “Geopolitical Oil Price Risk and Economic Fluctuations,” Federal Reserve Bank of Dallas Working Paper No. 2403.

Kilian, L and X Zhou (2022a), “The Impact of Rising Oil Prices on U.S. Inflation and Inflation Expectations in 2020-23”, Energy Economics 113: 106228.

Kilian, L and X Zhou (2023), “A Broader Perspective on the Inflationary Effects of Energy Price Shocks”, Energy Economics 125: 106893.

Krugman, P (2026), “The Oil Crisis is About to Get Physical”, 31 March.