Stagflation: When the Economy Stalls and Prices Soar

TL;DR (SUMMARY) Stagflation represents the worst macroeconomic scenario: high unemployment combined with economic stagnation or contraction plus an accelerated rise in prices. Unlike isolated economic problems, combating stagflation creates a dilemma with no simple solution, as measures to curb recession tend to worsen inflation and vice versa.

Why Does It Matter to Understand Stagflation?

The fundamental dilemma of stagflation lies in its contradictory nature. Normally, a weak economy keeps prices under control because demand falls. However, during stagflation, prices rise even when the economy is collapsing. This creates a scenario where policymakers find themselves trapped: acting against the recession worsens inflation, and vice versa.

When the gross domestic product (GDP) stagnates or declines while unemployment rises and prices soar, the purchasing power of citizens erodes rapidly. It is an unusual but devastating phenomenon.

Definition and Origins of the Term

Stagflation is a macroeconomic concept coined in 1965 by Iain Macleod, a British politician and Chancellor of the Exchequer. The term combines “stagnation” and “inflation” to describe an economy that simultaneously experiences minimal or negative growth, high unemployment, and rising consumer prices.

What makes stagflation unique is its break from the typical relationship between employment and prices. Normally, when employment is high and the economy is growing, inflation arises as a secondary effect. In contrast, stagflation reverses this logic: unemployment rises while prices also soar.

The Root Causes of Stagflation

Incompatibility between Fiscal and Monetary Policies

Central banks like the Federal Reserve control the money supply through monetary policy, while governments influence the economy through taxes and spending (fiscal policy). When these two forces work in opposite directions, stagflation is born.

A practical example: a government raises taxes, reducing consumer spending, while simultaneously the central bank implements quantitative easing (money issuance) or lowers interest rates. The result is economic contraction combined with accelerated inflation.

The End of the Gold Standard

Before World War II, the major economies pegged their currencies to the gold standard (, which naturally limited the money supply. With the mass adoption of fiat currency, this limitation disappeared. While it freed central banks to manage the economy with greater flexibility, it also removed natural barriers against runaway inflation.

) Increases in Supply Costs

When production costs skyrocket —especially in energy— what economists call “supply shock” occurs. If energy prices rise ###like oil(, goods cost more to produce. Consumers pay higher prices while their incomes are eroded by energy costs, creating the perfect conditions for stagflation.

The Perspective of Different Economic Schools

) The Monetarists: Control of Money First

Monetarists argue that controlling inflation should be the priority. Their strategy: reduce the money supply to decrease overall spending, lower demand, and curb prices. The downside is that this policy does not stimulate growth or employment, issues that will need to be addressed later.

Supply Economists: Increase Production

This school holds that the solution lies in increasing efficiency and reducing production costs. Production subsidies, investments in technology, and control of energy prices ### when possible ( can increase aggregate supply, reduce prices, stimulate production, and simultaneously decrease unemployment.

) The Free Market: Let Time Solve It

Some economists believe that the best cure is to allow supply and demand to self-adjust. Over time, consumers will not be able to buy, demand will decrease, prices will drop, and the labor market will stabilize. The criticism is obvious: this process can take years or decades while the population suffers from deplorable economic conditions.

The Stagflation of 1973: Historical Lesson

The 1973 oil embargo by the Organization of Arab Petroleum Exporting Countries ###OAPEC( —imposed in response to the Yom Kippur War— demonstrated how a supply shock can create stagflation.

With oil running scarce, prices skyrocketed. The central banks of the United States and the United Kingdom responded by lowering interest rates to stimulate growth. However, this decision was counterproductive: energy costs were already prohibitive, demand did not significantly rebound, but inflation continued to accelerate. The result was a decade of economic stagnation with high inflation.

Impact of Stagflation on the Cryptocurrency Market

) Purchasing Power Contraction

In contexts of minimal or negative growth, consumers have less money available to invest. Retail investors cut exposure to high-risk assets like Bitcoin and other cryptocurrencies to cover basic expenses. Institutional investors also reduce positions in high-risk assets during economic contractions.

The Effect of Interest Rates

When a government tries to curb inflation by raising interest rates, liquidity contracts. With banks offering returns on deposits and more expensive loans, cryptocurrencies —which do not generate yield— become less attractive. The prices of Bitcoin and altcoins typically fall during interest rate hike cycles.

On the contrary, once inflation is under control and quantitative easing begins with lower rates, the environment for cryptocurrencies improves significantly.

Bitcoin as a Hedge Against Inflation

Many investors see Bitcoin as a store of value during high inflation, thanks to its limited supply of 21 million and its immutable nature. With accelerating inflation, holding wealth in fiat currency without yield erodes its real value. Bitcoin promises to preserve purchasing power in the long term.

Historically, this strategy worked well for those who accumulated Bitcoin during periods of monetary expansion. However, during stagflation ###contraction + inflation simultaneously(, the hedging benefit may not materialize in the short term. Additionally, the increasing correlation between cryptocurrencies and stock markets complicates the equation.

Difference Between Stagflation and Simple Inflation

Inflation, by itself, describes a rise in prices or a decrease in purchasing power. It is a problem, but predictable: with economic growth and high employment, inflation is “normal.” Stagflation is categorically different: inflation occurs without the expected growth that accompanies it, making the situation exponentially worse for citizens and policymakers.

Conclusion: A Dilemma with No Winners

Stagflation presents a unique challenge because it violates the typical laws of economics. Tools to combat recession generate inflation, while measures to control inflation deepen the recession. There is no clean solution; only painful trade-offs.

In stagflation contexts, it is crucial to analyze the macroeconomics as a whole: money supply, interest rate levels, supply and demand dynamics, and employment rates. No factor acts in isolation. Understanding stagflation is understanding why economic policy, even well-intentioned, sometimes worsens what it attempts to resolve.