This new episode of escalating tensions in the Middle East brutally brings back to the centre of debates the inextricable link between the dynamics of fossil fuel prices (oil, natural gas) and global economic growth. Unfortunately, and somewhat surprisingly, the recent episode joins a series of relatively similar events that have occurred over the last 50-60 years. The vulnerability of transit through the Strait of Hormuz and the reconfiguration of the positions of oil-exporting states reprofile the spectrum of the oil crises of the 1970s, while the role and strategy of OPEC (Organization of the Petroleum Exporting Countries) return once again to the centre of the global energy equation. From a certain perspective, the fragility of the world economy in relation to the same factors for more than 50 years is apparently incomprehensible.

From the 1970s to the present – the lessons of the oil crises and their relevance to the current situation

In the 1970s, OPEC functioned as a cartel of oil-exporting countries, using production levels to influence prices on the world market. Supply constraints and embargoes, in particular, were used as economic and political instruments that contributed decisively to the triggering and aggravation of oil crises. It is important to mention the first two oil crises, the one triggered in 1973, in the context of the Yom Kippur War, and the second, in 1979, which arose against the backdrop of the Iranian Revolution. The first, determined by OPEC’s decision to impose an oil embargo on Western countries, led to steep price increases, fuelling inflation and causing economic stagnation; the second amplified the instability of the global energy market by considerably reducing the oil supply. Therefore, the oil crises of the 1970s not only significantly influenced the evolution of the world economy, but also unequivocally exposed the dependence of industrialized countries on external energy resources. Given the scale of their impact, these crises marked the first structural impetus for reconfiguring global economic and energy policies, driving the diversification of energy sources, the creation of strategic reserves, and the consolidation of the concept of energy security, while also prompting efforts to improve energy efficiency and reduce unit consumption.

“Volcker disinflation” – from the oil shock to the monetary policy response

The arrival of Paul Volcker as chairman of the Federal Reserve in 1979, against the backdrop of already very high inflation, meant a highly restrictive monetary policy (very high interest rates), known as the “Volcker disinflation”. This conduct was adopted precisely to combat high inflation, generated largely by the oil crises, but also by other imbalances created in the 1970s. Although it led to a severe recession in the short term, this strategy managed to reduce inflation and restore macroeconomic balance.

The new element of the current crisis: physical disruptions to oil and LNG supply

Returning to the Middle East crisis, according to statements given to Reuters by the CEO of QatarEnergy and Minister of Energy, Saad al-Kaabi, the attacks attributed to Iran have disabled about 17% of Qatar’s liquefied natural gas (LNG) export capacity, generating annual losses estimated at about 20 billion dollars and endangering supplies to Europe and Asia. According to him, two of the 14 gas liquefaction facilities, as well as one of the two units for transforming gas into liquid fuels, were damaged following unprecedented attacks. For this reason, a production capacity of about 12.8 million tons of LNG per year will remain unavailable for an estimated period of three to five years.

OPEC’s conduct becomes the determining factor in the medium term

In this context, as we can see the serious damage to the production capacity of the Middle Eastern countries and the significant costs of its restoration, a relevant question that can be addressed is what strategy the Middle Eastern countries will adopt on the oil market in the coming years and how they will influence OPEC decisions. If we follow the evolutionary pattern that followed the 1970s, we can see how OPEC decisions regarding the voluntary adjustment of the level of hydrocarbon production and the evolution of their quotations had the potential to generate significant fluctuations in the financial markets, with second-round effects on the global economy. Today, however, a new element appears – by affecting the production capacity and disrupting the distribution routes, the very viability of the production of the Middle Eastern states is altered. Thus, we can ask ourselves whether, in order to compensate for the financial losses and the physical damage to the infrastructure for the extraction, processing, and delivery of oil and its derivatives, Middle Eastern states will once again resort to cartel-type policies, similar to those of the 1970s, with the implicit aim of maintaining high oil and gas prices, in order to recover losses and finance the restoration of the infrastructure.

Scenario of cost transfer to oil importing economies

In such a scenario, maintaining high hydrocarbon prices for a longer period of time through OPEC’s strategy even after the end of the military conflict in the area would be equivalent to transferring the burden of restoring production capacities to OPEC clients, namely the states dependent on energy sources in the Middle East, in this case the European Union, Japan, China, India, or South Korea.

Therefore, in this pessimistic scenario, the inflationary surge determined by the increase in energy prices could persist for a longer period of time.

The dominance of energy policy – Europe’s new economic constraint

At the same time, a potential LNG supply shock would have macroeconomic implications for Europe that go beyond energy markets. Unlike the oil shocks of the 1970s, which mainly affected transport and logistics costs, natural gas now occupies a much more important structural position in the European economy. It is both an essential input for energy-intensive industries and a major determinant of the marginal price of electricity in European markets.

In these significantly different circumstances, an LNG supply shock should be interpreted not only as a sectoral disruption, but as a systemic shock to the cost structure of the European economy. We can assume that the impact is quickly transmitted from the gas market to the electricity market, then to energy-intensive industry and finally to the entire production chain in the economy. These mechanisms inevitably generate second-round effects on inflation and industrial competitiveness.

Thus, a question that seemed to have already been outdated in the European debate resurfaces: if gas becomes prohibitive, can Europe temporarily resort to fossil fuels such as coal? From the perspective of the energy transition, such an evolution seems counterintuitive for a continent with major concerns about the production of green energy from renewable sources. However, economic history shows that, in situations of severe supply constraints, energy systems tend to privilege security of supply. Geopolitical developments can thus lead to energy policy decisions that temporarily contradict the optimal and meritorious logic of the long-term transition.

Would the Volcker solution be as effective in Europe today?

Continuing the logical thread from the perspective of the economic policies of the states dependent on energy imports mentioned above, the natural approach is to analyse the relevance of Volcker-type measures to reduce inflation as a valid option in the present circumstances, knowing the interdependencies (and limitations) arising from the current positions of fiscal and macro-prudential policies.

Despite the historical similarities with the 1970s, in the current circumstances we have a different general picture, because the context is positively differentiated by a higher degree of diversification of energy sources, more options for hydrocarbon suppliers (including from outside OPEC), as well as a lower degree of energy intensity of most developed and emerging economies. Of course, even under these conditions, an episode of persistent inflation driven solely by an energy price shock is possible (and could be aggravated by possible joint decisions by OPEC countries of the type adopted in the 1970s), but it is less likely to reach the magnitude of shocks observed in the past. This is the conclusion reached by Paul Krugman in his recently published editorial Oil Crises, Past and Possibly Future: What the 70s can and can’t teach us.

At the same time, given the current macro-financial circumstances, the room for manoeuvre of monetary policy at the European level is probably more limited compared to that specific to the US economy in the Volcker era. For example, Ricardo Reis reaches similar conclusions in his work What Can Keep Euro Area Inflation High? (2023), highlighting a series of circumstances that limit the capacity for manoeuvre of monetary policy within the euro area.

Therefore, I believe that it would not be appropriate for a monetary policy response at the European level to replicate an approach similar to the Volcker model of the past today. In the current context, a carefully calibrated response is likely to be more effective, as it accounts for the increasingly complex network of economic and financial constraints that influence not only price dynamics, but also financial stability, the evolution of the gap between nominal and potential GDP, and fiscal sustainability. Therefore, the appropriate approach at the moment would be a “balancing act”, supported simultaneously by a recalibration of the macroeconomic policy mix.

What policy mix can respond to this type of shock?

We can start with the 1980s. From a macroeconomic perspective, the comparison with the Volcker era highlights a fundamental difference: in the US in the 1980s, inflation was driven by both energy shocks and fundamental factors, represented by a wage-price spiral and unanchored inflationary expectations. However, in Europe today, a significant part of inflationary pressures is driven by external supply-side factors, in particular energy costs.

This current reality, as we have shown above, naturally limits the effectiveness of monetary policy instruments, which act predominantly on the demand side. A monetary policy that abruptly becomes highly restrictive can reduce aggregate demand and prevent the transmission of inflation to core wages and prices, but it cannot relax energy supply constraints. In these circumstances, a large monetary adjustment alone risks contributing to a sharper economic contraction rather than addressing the effects of an energy supply imbalance. At the same time, the current fiscal context in Europe is radically different from that of the Volcker period in the US. Public debt levels are much higher in many European economies, which limits the room for manoeuvre. Sharp increases in interest rates would amplify pressures on fiscal sustainability, could generate risks of financial fragmentation and destabilisation of the macro-financial framework.

A new constraint in the policy mix: Energy Dominance

From a macroeconomic perspective, the European economy seems to be approaching a situation that could be described as “Energy Dominance”, in which the room for manoeuvre of monetary and fiscal policies is affected. Recent energy crises suggest the emergence of a third constraint: situations in which the availability and cost of energy become the dominant factors of macroeconomic dynamics in the short and medium term, as well as conditionality for the effectiveness of monetary and fiscal policies.

In a regime of Energy Dominance, most traditional macroeconomic stabilization instruments become less effective. Monetary policy can influence demand, and fiscal policy can redistribute the costs of adjustment, but neither can quickly change the physical constraint of infrastructure and security on the effects generated by energy supply.

This reality shapes Europe’s economic policy framework. In the emerging new normal, macroeconomic stability depends not only on central bank policy and governments’ fiscal discipline, but increasingly on the pace and scope of energy diversification, the flexibility and resilience of the energy system, and the overall energy efficiency of the economy.

For Romania, this would translate into the need to continue investing in energy infrastructure (Romania currently benefits from a good diversification of energy production resources), improving and expanding nuclear capacities, exploiting the resources of the Black Sea and, last but not least, maintaining the forefront of projects developed using renewable energy. At the same time, in the short term, importance must be given to increasing energy efficiency and modernizing transmission and distribution networks in order to optimally use existing resources.

In the current economic environment, marked by rising tensions and increased volatility in international markets, it is essential to both strengthen energy independence and develop effective instruments for the short-term management of economic imbalances. Once again in recent history, we are facing a crisis that is acquiring global dimensions and disrupting international distribution and supply networks.