Understanding stagflation: an economic challenge that also impacts cryptocurrency investors

QUICK SUMMARY Stagflation emerges when an economy simultaneously faces high unemployment, contraction of growth, and rising prices. Unlike conventional economic problems that are addressed independently, this combination presents a dilemma: measures that curb inflation accelerate the recession, and vice versa.

Background: Why is stagflation so complex?

To understand why stagflation is so complicated, we first need to examine how governments normally address each problem separately.

When there is an economic recession, authorities expand the available money, reduce interest rates, and facilitate credit. This encourages businesses and consumers to invest and spend, driving employment and growth.

But in the face of inflation, the strategy is the opposite: to contract the money supply, raise interest rates, and discourage spending. Lower demand eventually reduces prices.

The problem arises when both conditions coexist: applying remedies for recession worsens inflation, and combating inflation deepens economic contraction. This is the central dilemma of stagflation.

What does stagflation actually mean?

The term was coined in 1965 when the British politician Iain Macleod merged “stagnation” and “inflation” to describe a then-uncommon economic phenomenon: minimal or negative economic growth combined with persistently high unemployment and simultaneous increases in consumer prices.

Normally, these indicators do not appear together. When the economy grows, employment rises and inflation tends to accelerate. When inflation is severe, the economy slows down. But in stagflation, both negative dynamics intertwine.

This situation greatly hinders macroeconomic management, as any intervention by central banks or governments may prove counterproductive.

The Roots of Stagflation: Common Causes

Supply shocks in critical sectors

One of the most common triggers is the abrupt increase in production costs, especially in energy. When the price of oil skyrockets, transportation, heating, and manufacturing costs rise dramatically. Producers pass these costs onto prices, generating inflation. At the same time, consumers have less purchasing power because they spend more on energy, reducing their spending on other goods. This slows down the economy.

Misaligned monetary and fiscal policies

Central banks manage the money supply through monetary policy (interest rates, quantitative easing). Governments influence through fiscal policy (taxes and public spending). When these tools work in opposing directions, they can generate stagflation.

For example: a government reduces spending or raises taxes, contracting the economy; while the central bank simultaneously injects money to stimulate. The result is abundant money but with low demand for real goods, which puts pressure on prices without creating jobs.

The end of the gold standard

Historically, major economies anchored their currencies to gold reserves, which limited the amount of money they could create. After World War II, this system was abandoned in favor of fiat currency (legal tender without backing by tangible assets).

Without these limitations, central banks gained greater flexibility but also increased the risk of uncontrolled inflation, especially if they combine monetary expansion with weak supply policies.

How Stagflation Specifically Affects Cryptocurrency Markets

For investors in Bitcoin and other cryptocurrencies, stagflation presents a complex scenario with multiple layers.

First phase: rising interest rates

When governments combat stagflation by prioritizing inflation, they typically raise interest rates. This shifts capital towards safe investments (bonds, bank deposits) and away from volatile assets like cryptocurrencies. Retail investors, facing inflation and economic contraction, reduce risk exposure. The result: downward pressure on crypto prices.

Second phase: later stimuli

Once inflation eases, governments often pivot towards monetary expansion to revitalize growth. Here, the increase in liquidity typically favors risk assets, including Bitcoin and tokens. Prices can recover significantly during this phase.

The role of Bitcoin as an inflation hedge

Many investors see Bitcoin as a store of value against persistent inflation, precisely because its supply is limited to 21 million units. Theoretically, while fiat money loses purchasing power, BTC should maintain or increase its relative value.

However, this thesis works better in long cycles of years. In short periods of stagflation, Bitcoin can fall simultaneously with stocks, especially if interest rates rise aggressively. The correlation with stock markets has also strengthened in recent years, further complicating this equation.

Conflicting Perspectives: How Different Economic Schools Propose to Combat Stagflation

The monetarist position

Monetarists argue that controlling the money supply is the top priority. Reducing the money in circulation decreases aggregate demand, putting downward pressure on prices. The downside: this medicine is recessionary in the short term, without directly addressing growth.

The supply approach

Other economists suggest that the real problem is the insufficiency of goods and services. The solution lies in reducing production costs (subsidies, investing in efficiency), controlling energy prices when possible, and incentivizing production. This expands aggregate supply, moderating prices while stimulating employment.

The vision of free market

Some advocate letting supply and demand self-correct: consumers, unable to pay high prices, reduce purchases; this contracts demand and prices; investors realign looking for opportunities. The problem: this adjustment can take years or decades of real economic suffering for the population.

The historical precedent: the oil crisis of 1973

In October 1973, the Organization of Arab Oil Exporting Countries (OAPEC) imposed an oil embargo against countries that supported Israel in the Yom Kippur War. The oil supply collapsed, multiplying prices and generating widespread shortages.

At the same time, central banks in the United States and the United Kingdom reduced interest rates in an attempt to preserve growth. This expansive policy, in the presence of expensive oil and soaring inflation, resulted in disaster: they simultaneously experienced double-digit inflation rates and severe economic stagnation. It was a textbook case of stagflation, confirming that traditional tools often contradict each other when both problems coexist.

Final Considerations

Stagflation represents a unique dilemma for economic policymakers because it combines two dynamics that rarely coexist. There is no one-size-fits-all or universally effective solution; different historical contexts and economic frameworks suggest different remedies.

For cryptocurrency investors, understanding stagflation is crucial because the behavior of Bitcoin and other digital assets during these phases critically depends on which monetary policy tool prevails at any given moment. Periods of rising rates typically push prices down; subsequent expansive phases can bring significant recovery. Maintaining diversification and clarity about the underlying macroeconomic cycle is essential for navigating these environments.