Stagflation: When the economy "hangs" between rise and inflation

Brief introduction to the problem: Stagflation is a rare but dangerous state of the economy when GDP growth slows down or becomes negative, unemployment remains high, and prices continue to rise. This phenomenon creates a paradox for policymakers: methods to combat inflation exacerbate stagnation, and vice versa.

Paradox of Economic Policy

Usually, inflation and economic growth go hand in hand. When the economy expands, people spend more, demand rises, prices increase, but this is accompanied by job creation. However, stagflation destroys this logic.

To stimulate the rise, central banks lower interest rates and increase the money supply. Loans become more accessible, people spend more, and companies expand production. At the same time, the fight against inflation requires opposite measures: raising interest rates, reducing the money supply, and limiting lending. These two policies, if applied simultaneously or in a wave-like manner, can lead to the worst of both worlds — economic stagnation combined with rising prices.

What exactly does stagflation mean

The term “stagflation” was proposed by British politician Ian Macleod in 1965 and represents a blend of the words “stagnation” and “inflation”. The condition is characterized by the simultaneous presence of several negative factors:

• Minimum or negative rise of gross domestic product
• High level of unemployment
• Rising prices for goods and services
• Decrease in the purchasing power of money

The classic correlation between employment and inflation is breaking down. When GDP figures fall and inflation accelerates, stagflation can lead to a financial crisis as the economy loses its ability to self-regulate.

Mechanisms of Stagflation Emergence

Confrontation of monetary and fiscal policy

The Federal Reserve System and similar central banks manage the money supply and set interest rates — this is monetary policy. Governments influence the economy through tax policy and government spending — fiscal policy.

When one side tries to stimulate the rise, while the other restrains inflation, a conflict arises. For example, the government raises taxes, reducing citizens' spending, while the central bank conducts quantitative easing (printing money) and lowers interest rates. The result: the economy slows down due to budgetary policy, but the money supply grows, supporting inflation.

Abandonment of the gold standard and transition to fiat currency

After World War II, most major economies abandoned the peg of their currencies to gold reserves. Although this gave central banks greater flexibility, it introduced the risk of uncontrolled expansion of the money supply. Without the natural constraint of gold reserves, the possibility of triggering inflation sharply increased, especially in the presence of other negative factors.

Energy crisis and supply shortage

The sharp rise in energy resources, especially oil, is a classic trigger of stagflation. When production becomes more expensive, prices for goods increase. At the same time, consumers spend more on utilities and transportation, leaving them with less money for other expenses. Demand falls, but prices do not decrease — stagnation occurs alongside inflation.

How Economic Schools Propose to Solve the Problem

Monetarist approach

Economists who consider managing the money supply a priority recommend reducing the money stock. This decreases overall spending, consumer demand falls, and prices start to decrease. However, this approach slows down economic growth even more. Additional measures of soft monetary policy and stimulating fiscal policy are needed to stimulate growth.

Supply-oriented approach

Another school focuses on increasing the supply of goods and services. Price control on energy resources, investments in production efficiency, and subsidizing producers help reduce costs. Increasing supply can simultaneously lower prices and stimulate growth, reducing unemployment.

Free Market Strategy

Some economists insist on non-intervention. In their opinion, supply and demand will naturally halt the rise in prices: consumers will not be able to buy expensive goods, demand will drop, and inflation will decrease. The free market efficiently allocates labor, reducing unemployment. Critics of this approach point out that the process may take years or decades, during which the standard of living for the population will remain low.

How Stagflation Affects Cryptocurrency Markets

The influence of macroeconomic conditions on cryptocurrency is ambiguous, but it is possible to analyze probable scenarios.

Reduction of retail investment

When economic growth slows or contracts, household incomes decline. Consumers focus on necessary expenses, cutting back on investments in risky assets, including cryptocurrencies. Retail investors need fiat money, so they start selling digital assets. At the same time, large investors pull capital out of high-risk assets, including stocks and cryptocurrencies.

The impact of the rise in interest rates

Governments usually prioritize controlling inflation. Increasing interest rates and reducing the money supply lower liquidity — people prefer to keep their money in bank accounts, loans become more expensive. In these conditions, high-risk investments become less attractive. Demand for cryptocurrency decreases, prices drop.

Possible recovery after inflation control

When the government takes inflation under control, a phase of growth stimulation usually follows: quantitative easing, lowering interest rates. An increase in the money supply is favorable for cryptocurrency markets — capital seeks returns in risky assets.

Bitcoin as insurance against inflation

Many investors view Bitcoin as a store of value, especially in the context of rising inflation. Fiat money without interest loses purchasing power, while Bitcoin with a limited supply of ( 21 million coins ) can serve as a hedge. This strategy is particularly effective for long-term holders who have accumulated cryptocurrency over the years.

However, the use of cryptocurrencies as a hedge against inflation may be ineffective in the short term, especially during stagflation. Furthermore, cryptocurrencies are increasingly correlating with stock markets, reducing diversification benefits.

Historical example: the oil embargo of 1973

The Organization of Arab Petroleum Exporting Countries (OPEC) announced an oil embargo in response to the position of Western countries during the Yom Kippur War of 1973. The sharp reduction in supply led to a surge in oil prices. The energy resource shortage cascaded into the food industry and transportation—everything became more expensive.

The USA and the UK initially lowered interest rates, stimulating borrowing and spending. However, to combat inflation, the opposite was required — a rise in rates. This policy imbalance led to high inflation combined with stagnation in Western economies. The 1970s period demonstrates a classic case of stagflation caused by an energy shock and political mistakes.

Final assessment

Stagflation remains one of the most challenging issues for macroeconomists and policymakers. Inflation and negative growth rarely coincide, but when they do, standard economic policy tools become ineffective or counterproductive. The solution requires a deep analysis of factors: the state of the money supply, interest rates, the balance of supply and demand, and employment dynamics. For investors, especially those interested in cryptocurrencies, understanding stagflation is critical for long-term portfolio planning.