Stagflation: definition and impacts on financial markets

Summary When an economy is trapped between massive unemployment and stagnation of growth on one side, while prices are skyrocketing on the other, it is referred to as stagflation. This paradoxical macroeconomic phenomenon makes government interventions particularly tricky, as measures that fight inflation generally worsen the recession, and vice versa.

Stagflation Explained: An Economic Challenge Without Easy Solutions

Origins of the concept

The term “stagflation” was coined in 1965 by British politician Iain Macleod, Chancellor of the Exchequer. It merges two contradictory economic realities: stagnation (absence of growth or negative growth) and inflation (generalized price increase).

This combination refers to a situation where consumers' purchasing power erodes rapidly while simultaneously, jobs become scarce and economic activity wanes. Unlike conventional economic wisdom, where growth and employment progress together towards moderate inflation levels, stagflation destroys this typically observed positive correlation.

The dilemma of decision-makers

Normally, fighting a recession involves increasing the money supply: central banks lower interest rates, reduce the cost of borrowing for businesses, and stimulate spending. At the same time, inflation is controlled by restricting the money supply and tightening rates, thus slowing consumption and stabilizing prices.

But when stagflation and inflation strike simultaneously, these two arsenals become incompatible. Any action to restore growth risks amplifying price increases; every effort to stifle inflation exacerbates economic paralysis. Gross domestic product stagnates or declines, unemployment rises, prices increase: it is a deadlock.

Why does stagflation emerge?

The contradictory policies: a major source

A government can adopt a restrictive tax policy (increasing taxes, reducing public spending) while the central bank pursues an expansionary monetary policy (quantitative easing, lowering rates). The result: consumers have less purchasing power, slowing growth, but the money supply increases, fueling inflation. This inconsistency creates the perfect environment for stagflation.

The abandonment of the gold standard

Before World War II, major economies backed their currencies with gold reserves. This mechanism imposed a natural limit on money creation. Its gradual abandonment and the transition to fiat currency (currency without material backing) freed central banks from this constraint. Paradoxically, this freedom also opened the door to excessive monetary expansions, fostering structural inflation.

Supply shocks

A drastic increase in production costs—especially energy prices—creates a supply shock. If goods become more expensive to manufacture, companies pass this increase onto selling prices. Consumers, themselves impoverished by more expensive energy (fuel, heating), reduce their purchases. Result: widespread inflation + collapsed demand = stagflation.

Lesson from the Past: the 1973 Oil Embargo

The OPEC (Organization of the Petroleum Exporting Countries) declared an embargo in 1973 to protest against Western support for Israel during the Yom Kippur War. The supply of oil collapses, prices explode, and supply chains dislocate.

In the United States and the United Kingdom, central banks are responding by lowering interest rates to stimulate growth. However, this remedy exacerbates inflation: money circulates more, but goods and services remain scarce. For years, both regions have been experiencing rampant inflation and economic stagnation simultaneously—a textbook stagflation that paralyzes policymakers.

The Schools of Thought Facing Stagflation

The monetarist approach

Monetarists prioritize controlling the money supply as a primary lever. In the face of stagflation, they radically reduce the amount of money in circulation, raise interest rates, compress consumption, and lower prices. The major downside: this austerity often deepens the recession before curing its symptoms.

The school of supply

These economists prioritize increasing productive capacity. They recommend price controls on energy, investments in industrial efficiency, and production subsidies. The goal: to reduce costs, increase overall supply, naturally lower prices, and stimulate demand. It is a gentler strategy, but it requires time and significant public resources.

The liberal position

Some economists advocate for maximum non-intervention: letting the free market solve stagflation through the natural adjustment of supply and demand. Prices will eventually fall, unemployment will resolve itself without interference. However, this approach allows populations to suffer for years, even decades—hence Keynes's famous critique: “in the long run, we are all dead.”

Stagflation and cryptocurrencies: a complex link

The relationship between stagflation and crypto markets remains nuanced, as several forces act simultaneously.

The collapse of disposable income

A contracting or nearly stagnant economy sees household incomes stagnate or decline. Consumers have limited money to invest in speculative assets, including cryptocurrencies. Many are forced to sell their crypto positions to access cash for daily expenses. At the same time, large institutional investors are reducing their exposure to high-risk assets, including Bitcoin and altcoins.

The impact of interest rate increases

When monetary authorities tighten interest rates to fight inflation, they make borrowing more expensive and non-yielding investments (such as traditional savings) more attractive. In this context, volatile and non-income-generating investments—like crypto—lose their luster. Demand and prices collapse.

Bitcoin as a hedge: myth or reality?

Many investors argue that Bitcoin serves as a store of value against inflation, comparing its programmed scarcity of (21 million maximum BTC) to gold. Historically, some long-term holders have benefited from this protection, especially during post-inflationary periods.

However, during a phase of acute stagflation, this thesis struggles to validate itself. Liquidity shocks, the flight to safe assets, and the increasing correlation between crypto and stock markets contradict this narrative. In the short and medium term, crypto behaves more like a risk asset than a safe haven.

Government measures: a double-edged sword

A government typically first tackles inflation, then growth problems. The first phase ( raises rates, monetary reduction) weighs on crypto. Once inflation is under control, the second phase (quantitative easing, rate cuts) can revive demand for digital assets through an influx of liquidity.

Conclusion: stagflation, a puzzle without a universal solution

Stagflation remains a macroeconomic puzzle. Inflation and negative growth do not naturally coexist; their convergence reveals either external shocks (oil, health), or deeply miscoordinated economic policies.

No intervention can simultaneously solve stagflation without sacrificing one objective in favor of another. Decision-makers must weigh historical, geopolitical, and financial contexts, assess the money supply, interest rate structures, supply-demand dynamics, and employment rates. For cryptocurrency investors, stagflation remains a hostile environment—requiring strategic caution and a deep understanding of government interventions.