Stagflation in economics: The perfect storm that every investor must understand

TL;DR When the economy simultaneously suffers from high unemployment, negative growth, and rising inflation, we are facing stagflation. This combination is a headache for central banks and governments because the measures to combat one condition typically worsen the other. For cryptocurrency investors, understanding what stagflation is in economics is crucial.

The worst scenario: Stagnation + Inflation = Stagflation

Imagine this: your money loses value every day (inflation), but jobs disappear (recession) and the economy freezes. That is stagflation, a concept coined in 1965 by Iain Macleod, a British politician and Chancellor of the Exchequer.

Stagflation describes an economy trapped in an uncomfortable limbo: it grows minimally or contracts, unemployment rises, but prices also rise. It sounds contradictory because it is. Normally, when the economy grows, inflation also appears. When it enters a recession, prices drop. But in stagflation, both evils strike simultaneously.

The challenge is brutal: governments cannot use their usual tools. Increasing the money supply worsens inflation. Raising interest rates deepens the recession. It is a textbook economic dilemma.

How does stagflation arise in economics?

Misaligned monetary and fiscal policies

Central banks control the money supply ( monetary policy ) while governments handle taxes and spending ( fiscal policy ). If these policies go in opposite directions, they create chaos.

Example: a government raises taxes (less money in the hands of consumers) but the central bank lowers interest rates and issues money massively. The result: less real spending but more money floating, which generates inflation without growth.

The end of the gold standard

In the past, coins were backed by gold, which limited the amount of money that could be created. After World War II, this system was abandoned and fiat currency (money without gold backing) emerged. Central banks gained freedom but also responsibility: without physical limitations, the risk of uncontrolled inflation increased dramatically.

Supply cost shocks

When oil or commodity prices explode, production costs rise. Goods become more expensive to manufacture, their prices increase, and consumers have less purchasing power. If the economy also slows down, you have the perfect recipe for stagflation.

The 1973 Crisis: A Historical Lesson

In 1973, the OAPEC (Organization of Arab Petroleum Exporting Countries) declared an oil embargo. Oil supply collapsed, prices soared, and the supply chain panicked.

The United States and the United Kingdom lowered their interest rates to stimulate the economy. But it did not work as expected. The rising cost of energy continued to pressure consumer prices, while growth did not materialize. Result: pure stagflation. It was a bitter lesson that showed the limits of traditional economic tools.

Key difference: Stagflation vs. Simple Inflation

Inflation is just the rise in prices. Stagflation is that rise accompanied by unemployment and economic contraction. It is inflation with an allied enemy: recession.

The schools of thought on how to combat stagflation

Monetarists: Control money first

Monetarists believe that reducing the money supply is a priority. Their argument: if you control inflation first by reducing the money in circulation, raising rates(, growth can be stimulated later with expansionary fiscal policies. The downside: periods of short-term economic pain.

) Supply-side economists: Increase production

These economists say that the important thing is to reduce costs and improve efficiency. Control energy prices, invest in productivity, and subsidize production. If you produce more at a lower cost, prices naturally go down and the economy grows.

Free market: Let it correct itself

Some economists argue that the market self-corrects. When prices are too high, demand falls, prices drop, and the system rebalances. But there is a problem: this process can take decades while people suffer.

How does stagflation impact cryptocurrencies in the economy?

For investors in Bitcoin and other digital assets, stagflation presents a complex scenario:

Phase 1: Combat Inflation

When a government tries to control inflation, it typically raises interest rates and reduces liquidity. This is bad for Bitcoin and cryptocurrencies because:

• Investors withdraw money and deposit it in banks ###earn interest(
• High-risk assets like crypto are being sold off massively.
• The money supply is frozen

Phase 2: Stimulate Growth

Once inflation is under control, governments typically lower rates and inject money )quantitative easing(. Here Bitcoin can shine because there is more liquidity available and investors are looking for alternative assets that protect their wealth.

The “hedge” argument of Bitcoin

Many investors see Bitcoin as a hedge against inflation due to its limited supply )21 million coins(. Historically, accumulating BTC during inflationary periods has acted as a long-term store of value. However, in stagflation, especially in the short term, this strategy may not work because overall demand tends to drop first.

Moreover, Bitcoin is increasingly correlated with traditional stock markets, which reduces its effectiveness as a diversifier in macroeconomic crises.

The dilemma with no easy solution

Stagflation is the perfect political and economic dilemma because there is no one-size-fits-all solution. Any measure that alleviates one condition will likely worsen the other.

Understanding what stagflation is in economics is not just academic: it is essential for market navigators. If an economy enters stagflation, expect volatility in crypto, changes in asset correlations, and unpredictable central bank decisions.

What has been clear since 1973 is that economists still do not have a magic cure. Only imperfect tools and difficult decisions.