What is stagflation and why should you care?

Quick Summary

Stagflation is the economic scenario that every investor fears: when an economy stagnates or contracts while prices rise uncontrollably. High unemployment, no growth, but skyrocketing inflation. It seems like a nightmare for governments because they do not have a simple solution that works for both problems at the same time.

The dilemma that scares central banks

Imagine you are a central bank. You usually have two tools:

To stop a recession, you inject money: you lower interest rates, make borrowing cheap, and people spend more. The economy is revitalized.

To control inflation, you do the opposite: raise rates, tighten credit, people spend less, prices fall.

But in stagflation both occur together. If you inject money to reactivate, you worsen inflation. If you tighten, you deepen the recession. That is why economic experts say that facing stagflation is like trying to solve two mutually contradictory problems.

How does this economic monster come to life?

The term was coined in 1965 by Iain Macleod, a British politician, combining “stagnation” and inflation. But what causes both to occur simultaneously?

Contradictory economic policies: A government can raise taxes (less money in pockets) while the central bank expands the monetary base (more money in circulation). The result: prices rise but the economy does not grow.

The abandonment of the gold standard: Previously, money was tied to gold reserves. When this disappeared after World War II and fiat currency arrived, the natural brake on the money supply was removed. Now central banks can issue without limits, facilitating uncontrolled inflation.

Supply Shock: When the cost of producing goods rises dramatically (expensive energy, supply crisis), prices go up but production collapses. Exactly what happened in 1973.

The Lesson of 1973: When Oil Nearly Collapsed the West

In October 1973, the OAPEC (Organization of Arab Petroleum Exporting Countries) embargoed oil to several Western countries in support of Israel during the Yom Kippur War. The result was catastrophic for developed economies.

Without oil, energy prices soared. Supply chains broke down. Consumers paid more for everything. At the same time, the United States and the United Kingdom lowered interest rates in hopes of reviving growth.

It didn't work. What came was stagflation: extremely high inflation combined with a stagnant economy. It was the first major modern example of this phenomenon, and it showed that traditional economic tools have no magic solutions.

How different economic schools try to solve it

Monetarists say: control inflation first by reducing the money in circulation. Raise interest rates. Yes, there will be more pain in the short term, but inflation will fall. Then, when they control prices, they can stimulate growth. The problem: in the meantime, many people are suffering unemployment.

Supply-side advocates propose: lower production costs. Subsidize energy, invest in efficiency, reduce regulations. If you produce cheaper, inflation decreases on the supply side, not the consumption side. This stimulates production and employment simultaneously.

Market liberals believe: let the market adjust itself. Supply and demand will find a natural balance. Unemployment will self-regulate. But there is one detail: this could take years or decades, and the population would suffer greatly in the process.

Stagflation and cryptocurrencies: a complicated relationship

For crypto investors, stagflation presents a paradox.

When growth declines, consumers have less money to speculate. Cryptocurrency sales increase because people need cash for basic expenses. Large investors also flee from high-risk assets like Bitcoin and altcoins.

When interest rates rise, high-yield investments lose their appeal. Keeping money in the bank with high interest is safer than crypto risk. Cryptocurrency prices come under pressure.

But there is a silver lining: some investors see Bitcoin as a hedge against inflation. With high inflation, fiat money loses purchasing power. Bitcoin, with its limited supply, could preserve value better than traditional currencies.

The problem: historically this works over long periods, not in short periods. During severe stagnation, even Bitcoin can suffer if general panic drives everyone to seek liquidity.

What distinguishes stagflation from ordinary inflation?

Inflation is simply the rise in prices. The economy may be growing, unemployment may be low. It's normal, manageable.

Stagflation is inflation + recession + high unemployment. It is inflation with the worst possible macroeconomic scenario. You cannot combat it with the usual tools.

Conclusion: a problem without an easy solution

Stagflation remains one of the biggest challenges for politicians and central banks. It does not occur frequently, but when it does, it reveals the limitations of modern economic policy. The tools that combat inflation generate recession. Those that combat recession generate more inflation.

Therefore, in times of stagflation, the most important thing is to understand the complete context: available money, interest rates, supply and demand, employment. For cryptocurrency investors, it means being alert to how governments respond to stagflation because those decisions will determine whether Bitcoin and altcoins are safe havens or free falls.