Stagflation is characterized by the simultaneous freezing of the economy and a rise in prices.

Important: volume material. When the economy simultaneously experiences stagnation or contraction with high unemployment, while prices continue to rise — we are facing stagflation. This situation confounds authorities and central banks, as standard methods for solving one problem exacerbate another.

What Economists Face

Typically, economists solve two different problems separately. They overcome a recession by increasing the money supply — lowering interest rates, which makes loans cheaper, citizens gain access to borrowed funds, companies grow, and jobs are created.

To combat rising inflation, opposing methods are used: reducing the money supply, increasing interest rates, and complicating lending. Consumers save instead of spending, demand falls, and prices stabilize.

However, history knows periods when recession and inflation go hand in hand — this is stagflation, characterized by a combination of economic stagnation with rising overall price levels. Let's delve into this paradox in more detail.

Origin of the Concept

The term emerged in 1965 thanks to British politician Ian Macleod, who combined the words “stagnation” and “inflation”. The phenomenon describes an economy with zero or negative growth, simultaneously suffering from high unemployment and rising prices for goods and services.

The paradox is that the traditional link between employment and inflation is disrupted. Typically, low unemployment leads to rising prices, but in stagflation, this correlation disappears.

Gross domestic product is falling, inflation is accelerating — this combination threatens a financial crisis. Typical remedies for one ailment exacerbate another, creating a vicious circle for the country's leadership.

Mechanism of occurrence

The Collision of Monetary Policy with Tax Policy

The Federal Reserve System and similar central banks manage the money supply through mechanisms of monetary policy. At the same time, governments influence the economy by regulating taxes and spending — fiscal policy.

When these two instruments work in opposite directions, a problem arises. For example: the authorities raise taxes (reduce people's incomes and freeze growth ), while the central bank simultaneously prints money and lowers rates (inflates demand and prices ). The result is that the economy does not grow, but becomes more expensive.

Transition to fiat currency

Before World War II, major powers tied their money to the gold reserves — the gold standard. This limited the issuance of money to the volume of gold in the vaults.

After the war, the gold standard was abandoned in favor of fiat money. Restrictions disappeared, central banks gained maneuvering freedom, but at the same time opened the door to inflation. Money can be printed as needed, without being tied to real assets.

Energy crisis and supply shortage

A sharp jump in production costs — especially energy resources — quickly leads to stagflation. When oil prices rise, everything becomes more expensive: transport, heating, production of goods.

Consumers are spending more on energy and utilities, leaving them with less money for other purchases. Demand is falling, but prices are rising — classic stagflation is characterized by this asymmetry of demand and supply.

Three Schools of Combatting Stagflation

Monetarist approach

Monetarists believe that everything depends on the money supply. Their prescription: reduce the money supply, even if it freezes growth. When inflation is under control, one can switch to a loose monetary policy and stimulate the economy.

Criticism: the period between the reduction of money and the start of growth can stretch for years, which is painful for society.

Supply Economics

Another school suggests not cutting money, but increasing production. Subsidies for production, investments in efficiency, control of energy prices — all of this reduces costs and increases the supply of goods.

More goods in the market = prices fall. When supply increases, the economy begins to grow, unemployment decreases, and inflation goes away.

Market self-regulation

Some economists believe in the self-healing of the market. Supply and demand will balance themselves — people will stop buying expensive goods, demand will fall, prices will come back down, and the labor market will be redistributed.

Problem: this process may take decades of mass poverty. As John Keynes said, “in the long run, we are all dead.”

How it Affects Cryptocurrencies

Assessing the impact of stagflation on Bitcoin and other assets is not easy, but several scenarios are obvious.

Investment Compression

When economic growth slows down or becomes negative, people lose income. There is no money left for speculative investments — the cryptocurrency market is the first to experience an outflow.

Retail investors are selling crypto to survive the crisis. Institutional investors are unwinding positions in risky assets, including stocks and digital assets. Prices are falling.

Tight monetary policy

When the central bank fights stagflation, it first suppresses inflation: it reduces the money supply, raises interest rates, and withdraws liquidity from the system.

During this period, people are taking money out of risky assets and putting it into banks ( where they now pay interest ). Cryptocurrency demand is falling along with prices. Only when inflation is broken and stimulation begins ( quantitative easing, lowering rates ), does money return to the cryptocurrency markets.

Bitcoin as a hedge against inflation

Many view bitcoin as a hedge against currency devaluation. With rising inflation, money in the wallet loses purchasing power.

The limited supply of bitcoin (21 million coins) makes it attractive as a store of value. Investors who have accumulated BTC over the years can benefit during periods of inflation and growth.

But in the short term, especially during stagflation, this strategy may not work. Cryptocurrencies are highly correlated with stock markets — they fall along with stocks, even if they promise protection against inflation.

Lessons from the 1973 Oil Crisis

In 1973, OPEC countries declared an oil embargo in response to support for Israel during the Yom Kippur War. Supplies collapsed, and prices soared.

Result: oil deficit, rising energy costs, spike in food and goods prices. Inflation has accelerated.

In response, the central banks of the US and the UK lowered interest rates in an attempt to stimulate the economy. Loans became cheaper, and people started to spend.

But inflation could have been reduced by raising rates and encouraging savings. This confrontation led to Western countries simultaneously experiencing high inflation and economic stagnation — classic stagflation.

Results

Stagflation remains a mystery for economists. Inflation and negative growth rarely occur simultaneously, but when it does happen, standard tools do not work.

The struggle against one phenomenon inevitably exacerbates another. Therefore, during stagflation, it is necessary to deeply analyze the macroeconomic context: the money supply, interest rates, the structure of demand and supply, and employment dynamics. Without understanding the root causes, no measures will lead to success.