Understanding Stagflation: Definition and Its Implications in Economy and Cryptocurrencies

SYNTHESIS When the economy slows down while prices rise simultaneously, we face a phenomenon known as stagflation. This scenario combines high unemployment with economic recession and accelerated inflation. The complexity of this situation lies in the fact that measures to combat one of these problems tend to exacerbate the other, making stagflation particularly difficult to resolve.

Definition and Origin of the Concept

The term stagflation was coined in 1965 by Iain Macleod, a British politician and Chancellor of the Exchequer. It represents the linguistic fusion of two words: stagnation and inflation. This definition accurately describes an economy that simultaneously experiences minimal growth or even contraction, accompanied by persistently high unemployment and sustained increases in consumer prices.

What distinguishes stagflation from other economic crises is that it violates the historical correlation between employment and prices. Typically, high unemployment and inflation rarely coexist; when one increases, the other tends to decrease. The most telling indicator of this situation is the gross domestic product (GDP), which reflects both employment rates and the overall health of the economy. When GDP deteriorates while inflation persists, a more severe financial crisis can be triggered.

The Origins and Underlying Causes

Identifying why stagflation arises requires analyzing multiple factors simultaneously. There are various economic theories that provide different explanations: from monetarist perspectives to Keynesian approaches and modern classical models.

Economic Policy Discrepancies

Central banks, such as the U.S. Federal Reserve, regulate the monetary flow through monetary policy. At the same time, governments shape their economies through fiscal policy, manipulating taxes and public spending. When these two tools become misaligned, the outcomes can be counterproductive.

A typical scenario occurs when restrictive spending policies are simultaneously implemented (higher taxation, lower disposable income) along with monetary expansion (quantitative easing or interest rate cuts). The result: stifled economic growth but persistent inflationary pressure.

The End of Gold Backing

Historically, major economies linked their currencies to gold through the gold standard. This system was largely abandoned after 1945. The transition to fiat currency removed any quantitative restrictions on monetary issuance. While this provided greater flexibility to monetary authorities, it also eliminated a natural brake against uncontrolled inflation.

Production Cost Shocks

The rising cost of vital inputs, especially energy, directly impacts the global supply chain. When production costs soar and simultaneously reduce the available consumption of citizens ( due to higher expenditures on energy and transportation ), the result is inflationary pressure combined with contracted economic demand.

Stagflation vs. Inflation: Key Differences

Although both involve rising prices, they are distinct phenomena. Inflation refers to the widespread increase in prices and the corresponding loss of purchasing power. Stagflation, on the other hand, adds the element of economic contraction and high unemployment to this, creating a situation where economic deterioration coincides with rising prices.

Response Strategies: Divergent Approaches

The economic community proposes multiple solutions according to its school of thought.

Monetarist Perspective: These specialists prioritize reducing inflation as their main objective. Their strategy involves contracting the money supply, reducing overall spending. While this lowers prices, it has the secondary effect of slowing growth.

Supply Side Approach: Another group argues that increasing the availability of goods is key. They propose subsidies for production, control of energy costs, and investment in efficiency. By expanding the supply, prices would naturally decrease while employment would be stimulated.

Market Solution: Some economists believe that supply and demand will self-adjust. Consumers, lacking purchasing power, would reduce demand, putting downward pressure on prices. The labor market would also naturally rebalance, although potentially over the course of years.

The Historical Case of the 1973 Oil Embargo

In 1973, the Organization of Arab Petroleum Exporting Countries declared an embargo in response to the Yom Kippur War. This decision drastically reduced the oil supply, raising prices and causing shortages in global supply chains.

Economies such as the United States and the United Kingdom responded by cutting interest rates to stimulate growth. However, with energy costs devastating household budgets and monetary stimulus being insufficient, these nations simultaneously experienced high inflation and a stagnant economy. It was a textual example of stagflation in action.

Differentiated Impact on Cryptocurrency Markets

Negative Growth Phase

When the economy contracts, retail investors face decreased purchasing power and an urgent need for cash. This typically leads to liquidations of risky assets, including Bitcoin and altcoins. Institutional investors also reduce exposure to high volatility assets during these periods.

Political Response and Interest Rates

Governments usually combat inflation by raising interest rates and reducing monetary liquidity. This makes high-risk-high-return investments less attractive. During these phases, cryptocurrencies face downward pressure.

Later, when inflation is controlled, the stimulus phase comes: quantitative easing and interest rate cuts. Here, crypto markets typically benefit from abundant money.

Bitcoin As Protection Against Inflation

Many investors consider Bitcoin a hedge against accelerated inflation. Its limited supply and controlled issuance position it as a long-term store of value. However, this hedge works best over extended horizons. In short periods of stagnation, Bitcoin also faces pressure.

Additionally, the increasing correlation between cryptocurrencies and stock markets complicates this protection strategy.

Final Reflection

Stagflation presents a unique challenge for economists and policymakers. Unlike isolated inflation or recession, these two problems rarely coexist, and the tools to combat one typically worsen the other. Understanding stagflation and its multiple facets—money supply, interest rates, supply-demand dynamics, employment—is essential for making informed economic decisions in complex macroeconomic contexts.