By-Dr. Nirmal Singh,
Assistant Professor, Department of Economics
Easwari School of Liberal Arts, SRM University -AP (Amaravati)
Amid mounting geopolitical tensions, the global economy is beginning to reflect its macroeconomic consequences. Following recent military escalations involving the US, Israel, and Iran, the Iranian authorities have moved to block the Strait of Hormuz, one of the world’s most critical maritime chokepoints connecting the Persian Gulf to the Arabian Sea. Nearly 20 per cent of global oil and liquefied natural gas shipments, along with other essential cargo, pass through this route. Major economies such as India, China, and Japan are heavily dependent on it.
Unsurprisingly, these developments have sent shockwaves across both commodity and financial markets. With no significant shift in global demand conditions, inflationary pressures are increasingly being driven by supply-side factors. Energy prices, in particular, have surged, feeding into broader inflation metrics.
The situation is further complicated by the escalation of hostilities. The deployment of additional U.S. military forces to the region has raised concerns that the conflict could persist longer than initially anticipated, even as officials signal the possibility of a near-term de-escalation. Even in the event of an immediate ceasefire, crude oil prices are unlikely to decline quickly. Significant damage to oil-producing infrastructure could prolong supply constraints and keep prices elevated for an extended period. Taken together, these factors point to an almost unavoidable rise in inflation across global economies. Policymakers are thus confronted with a classic supply-side shock, inherently more difficult to manage than demand-driven inflation.
This raises a crucial question: how should economies respond? One possible, albeit costly, solution is to diversify energy import sources. However, in an already tight global market, securing alternative suppliers is neither easy nor immediate. For instance, Russian oil, which was previously available at discounted rates, is now being sold at a premium. This suggests that energy-driven inflation is not only inevitable but also likely to be persistent. For countries like India, the challenge is even more acute. A depreciating rupee adds further pressure by increasing import costs, thereby widening the current account deficit. The combined effect of high global prices and currency weakness amplifies domestic inflationary pressures.
Can monetary policy offer a solution? Central banks can respond by tightening monetary policy, raising policy rates to compress aggregate demand and prevent second-round effects, particularly the de-anchoring of inflation expectations. However, the effectiveness of such a response is limited in the face of a predominantly supply-side shock. Higher interest rates do little to ease supply bottlenecks or reduce imported energy costs; instead, they risk exacerbating the output-inflation trade-off by suppressing investment and consumption, thereby slowing growth. Yet, a completely accommodative stance could also be problematic. In the absence of a credible policy response, persistent cost-push inflation can feed into wage-setting behaviour and price expectations, potentially triggering a wage–price spiral
This places policymakers in a difficult position, caught between stabilising inflation and sustaining growth. At its core, the dilemma reflects a classic trade-off: adjusting demand to contain inflation without imposing a high cost on output. The challenge, however, lies in determining the extent and duration of such adjustment in the face of a largely exogenous supply shock.
