When the economy moves in two directions: understanding stagflation

When production falls, unemployment rises, and prices soar in the economy at the same time — it’s not just bad, it’s complicated. This phenomenon is called stagflation, and it creates a dilemma for politicians: treating one ailment with one remedy means exacerbating another.

History: How OPEC Taught the World to Fight Stagflation

Let's take the year 1973. The Organization of Arab Petroleum Exporting Countries imposes an embargo, oil supplies are sharply reduced. Energy prices soar, a chain reaction begins: goods become more expensive, production costs rise, and people pay more for fuel and food.

What are the central banks of the USA and the UK doing? They are lowering interest rates in the hope of stimulating spending and economic growth. The logic is clear: cheap loans should boost investments. But in reality, it turns out differently. Inflation does not fall, and the economy does not grow — it creates exactly the situation that economists considered almost impossible: simultaneous decline and rising prices.

What is really hidden behind the word stagflation

The term was proposed by British politician Ian Macleod in 1965, combining two words: stagnation (freezing of economic development) and inflation (rise in prices). But this is not just an academic definition — it is a dangerous condition in which standard economic tools yield the opposite result.

Typically, the connection works like this: low unemployment creates inflation because people spend a lot, and the supply of goods cannot keep up. High unemployment, on the other hand, suppresses prices. Stagflation breaks this logic: both rise at the same time.

When the gross domestic product falls and money becomes more expensive, the economy enters a downward spiral: people become poorer, businesses cut production, unemployment rises, and consumer demand falls even further. If this drags on, a financial crisis may occur.

Why Stagflation Occurs: Three Main Culprits

Monetary policy encounters fiscal — and conflict is inevitable

Central banks manage the money supply and interest rates. Governments influence the economy through taxes and budget expenditures. When these two instruments work in opposite directions, disaster ensues.

Imagine: the government raises taxes, people start saving, demand falls. At the same time, the central bank prints money and lowers rates. The result is paradoxical: there is more money in the system, but the real economy is freezing. This creates ideal conditions for stagflation.

When the state abandoned gold

Before World War II, most currencies were linked to gold reserves - this limited the rise of the money supply. After the war, the gold standard system collapsed, giving way to fiat currencies, backed only by the trust of the state.

This gave central banks the freedom to act, but created a new risk: they could print money without limits. When the economy weakened and the government demanded money, inflation became more likely. Stagflation became possible precisely in the era of fiat money.

Oil as a trigger

Energy resources are the artery of the modern economy. If oil prices rise, everything follows: electricity, delivery, production. Companies either raise prices or cut production. Consumers pay more and buy less. The economy simultaneously contracts and becomes more expensive — classic stagflation.

The supply shortage, whether it's energy resources or raw materials, acts as a massive tax on the entire economy.

Three Schools of Thought on How to Survive Stagflation

Monetarists: let's control the money

Monetarists believe that everything depends on the money supply. They say: inflation is the main enemy, we reduce money, raise rates, people start to save, demand falls, prices decrease.

Indeed, this does not solve the problem of unemployment and falling production. We will have to separately fight against the recession later — through soft monetary policy and fiscal incentives. It turns out to be like an “economic pendulum” with periods of crisis.

Supporters of the proposal: we need to produce more for less.

Another approach: the problem is not in money, but in supply. It is necessary to subsidize production, reduce costs, and increase efficiency. Control the prices of energy carriers. If there are more goods and they are cheaper, then inflation will fall, and the economy will grow.

Sounds logical, but in practice, government intervention often creates market distortions and new problems.

Supporters of the free market: let people decide

There are those who believe that stagflation is best cured by itself. People will not buy expensive goods, demand will fall, and prices will return to normal. The labor market self-regulates, finding equilibrium between wages and employment.

The catch is one: it may take years or decades of low living standards. As Keynes said, “in the long run, we are all dead.” No government can wait that long.

How Stagflation Shakes the Cryptocurrency World

People save, not invest

When economic growth stagnates, people spend less on risky assets. Stocks fall, cryptocurrency falls. Retail investors sell their bitcoins and altcoins because they need real money for food, utilities, gas.

Large investors are also massively reducing high-risk portfolios. The cryptocurrency market, sensitive to sentiment, is reacting with a sharp decline.

The central bank raises rates — cryptocurrency falls

The fight against inflation starts with one thing: reducing the money supply, raising interest rates. Then people prefer to keep their money in banks for interest rather than seek high-yield investments. The demand for cryptocurrency falls, and prices drop along with it.

This phase can last for months or years until inflation is suppressed.

When inflation is under control — cryptocurrency comes to life

As soon as the central bank takes inflation in its grip, it moves to the second phase: quantitative easing and rate cuts. The money supply increases, investors are once again seeking risky assets, and the cryptocurrency markets come to life.

Bitcoin as insurance against the rise of money

Many see Bitcoin as a hedge against inflation. When money loses value due to excessive printing, people look for something solid. Bitcoin has a fixed supply — a maximum of 21 million coins. It's like digital gold.

For long-term investors who have been accumulating cryptocurrency for years, such a strategy may work. But during stagflation itself, when everything is falling at the same time, Bitcoin may not help — it correlates with the stock markets and falls along with them.

Why Stagflation is a Headache for Politicians

Conventional economic policy tools do not work here. If you lower the rates to help the economy, you inflate inflation. If you raise the rates to suppress rising prices, you crush the economy and increase unemployment.

It is necessary to understand what exactly caused the stagflation: is it a problem with money, production costs, or consumer demand? The choice of treatment depends on the answer.

During stagflation, economists have to think differently than usual — not linearly, but multidimensionally. Money supply, interest rates, demand and supply, employment level — all these factors need to be analyzed as a unified system, not as separate variables. This is precisely why stagflation remains one of the most challenging tasks for macroeconomic policy.