The Iranian Revolution doubled oil prices again. The response, very high interest rates, caused a deep recession and changed economic policy.
The Iranian Revolution of 1979 cut Iran's oil exports. Panic buying followed, and the Iran-Iraq War from 1980 cut supplies further. Oil prices more than doubled, from about 14 dollars a barrel in 1978 to more than 30 dollars by 1980.
Inflation surged again. This time Western governments chose to fight inflation first. In October 1979 the US Federal Reserve under Paul Volcker began to squeeze the money supply. US interest rates rose to about 20 per cent.
High interest rates caused a deep recession in 1980-1982. Unemployment rose sharply in the USA and Europe, but inflation fell.
Governments also changed their thinking. Leaders such as Margaret Thatcher and Ronald Reagan turned away from managing demand. They moved towards free markets, lower taxes and less regulation.
Consumers and firms adapted. They used energy more efficiently, and new oil came from the North Sea and Alaska. By 1986 there was too much oil on the market, and prices collapsed.
- 1979
- Iranian Revolution; oil prices more than double.
- Volcker
- From October 1979: tight money, interest rates near 20 per cent.
- 1986
- Oil glut; prices collapse.
Worked example: Comparing the two oil crises
How did 1979 differ from 1973?
- Cause: 1973 was a political embargo; 1979 was a supply disruption and panic.
- Response: 1973 brought weak, mixed policies; 1979 brought high interest rates.
- Impact: 1979 fed directly into the debt crisis through high interest rates.
- Adaptation: by the 1980s economies used oil more efficiently.
Watch out for this
The 1979 crisis hurt the world economy only through higher oil prices.
Much of the damage came from the policy response. Very high US interest rates caused recession and made debts far harder to repay.
Check your understanding
Why did US interest rates rise to about 20 per cent around 1980-1981?
- The Federal Reserve was fighting inflation.
- OPEC set US interest rates.
- The IMF ordered it.