Stagflation: The concept that challenges traditional economics

An economic crisis from the past that remains relevant

To understand what stagflation is as a modern concept, it is instructive to look back to 1973. When OAPEC imposed an oil embargo, the world faced a perplexing economic paradox: prices soared while economies stagnated. The United States and the United Kingdom were confronted with rampant inflation combined with recession, a phenomenon that challenged the conventional economic wisdom of the time.

This historical scenario perfectly illustrates how two destructive forces can converge simultaneously. With energy costs at their peak and central banks unable to find effective solutions, the population experienced an unprecedented economic contraction. It was the first major reminder that stagflation is not a theoretical concept, but a tangible reality capable of destabilizing nations.

What does this complex concept imply?

The term stagflation was coined in 1965 by Iain Macleod, a British politician and then Chancellor of the Exchequer, merging “stagnation” and inflation to describe a particularly difficult economic situation.

Specifically, stagflation represents:

• Minimum or negative economic growth combined with persistently high unemployment
• Continuous rise in consumer prices (inflation) without the economy expanding
• An investment of the historical correlation between employment and prices

The peculiar thing about the concept is that it breaks traditional economic logic. Normally, when employment rises, inflation goes up. When inflation falls, there is unemployment. But in stagflation, both ills occur together, creating a practically unsolvable dilemma for policymakers.

The mechanisms that generate this perfect storm

Conflict between economic policy instruments

Central banks and governments have specific tools, but they operate in opposite directions:

To combat recession, they increase the money supply and lower interest rates, facilitating loans and stimulating spending. To contain inflation, they do the opposite: reduce circulating money and raise rates, discouraging investment and consumption.

When both crises converge, any action aggravates the other. Policies that relieve stagnation fuel higher prices. Measures against inflation deepen the recession.

The end of monetary anchoring

After World War II, major economies progressively abandoned the gold standard that artificially limited the issuance of money. The transition to fiat currency removed restrictions on how much money central banks could create.

Although this gave them greater flexibility, it also opened the door to excessive money circulating without backing, increasing inflationary pressures and potentially contributing to stagflation cycles.

Supply cost shocks

When production costs rise dramatically—especially energy—every good and service becomes more expensive. If at the same time consumers have less purchasing power, demand falls but prices do not. This situation on the supply side is especially problematic and was exactly what happened in 1973 with the oil embargo.

Different economic schools, different solutions

Economists do not have a single consensus on how to resolve stagflation, and their recommendations reflect their philosophies:

Monetarists prioritize stopping inflation first, reducing the money supply even at the cost of temporary growth. Growth would come later through complementary measures.

Supply economists propose to increase production by reducing costs, providing subsidies, and improving efficiency. With more goods available, prices naturally decrease without sacrificing jobs.

Free market defenders argue that they interfere as little as possible, allowing supply and demand to self-adjust. The problem: this process takes years or decades while the population suffers deplorable conditions.

Implications for Cryptocurrency Markets

How would stagflation penetrate the crypto ecosystem? The effects would be complex and contradictory:

During the inflation control phase

When governments combat high prices by raising interest rates, the available money for investing in speculative assets decreases. Cryptocurrencies, being high-risk, would suffer massive capital drainage. Retail investors would need liquidity for basic expenses, and institutions would reduce exposure to volatile assets.

When the economic stimulus arrives

Once inflation is controlled, governments typically expand money and lower rates to revive growth. In that scenario, cryptocurrencies would likely benefit from excess liquidity and a recovered risk environment.

The argument for Bitcoin as a hedge

Many investors see Bitcoin as a hedge against high inflation, arguing that its fixed supply makes it “emergency money” when fiat currency loses value. Historically, accumulating cryptos during inflationary periods has performed well in the long term.

However, during stagflation—especially in the short term—this strategy fails. The simultaneous recession puts pressure on risky asset prices, including crypto. Furthermore, the increasing correlation between cryptocurrencies and traditional stock markets weakens the argument for independent hedging.

Conclusion

Stagflation as a concept represents a unique challenge because its dual nature—negative growth plus inflation—means that no conventional economic tool works without side effects. It is a reminder that the real economy is more complex than simplified models.

For cryptocurrency investors, understanding stagflation is not academic: it directly affects portfolio decisions. In times of such macroeconomic pressures, simultaneously monitoring money supply, interest rates, employment, and aggregate supply is essential to navigate this perfect economic storm.