## Understanding Stagflation: Definition and Its Impact on Markets

**Quick Summary** When an economy simultaneously faces massive unemployment, GDP contraction, and sustained price increases, we are in a state of stagflation. Unlike typical economic scenarios, this situation creates a dilemma for policymakers: acting against inflation further slows down the economy, while boosting growth exacerbates prices. For cryptocurrency investors, this represents a complex environment.

## What does stagflation mean in simple terms?

Stagflation is a macroeconomic scenario where three evils coexist simultaneously: economic contraction ( or near-zero growth ), high unemployment, and rising consumer prices. The term was coined in 1965 by Iain Macleod, a British politician, combining "stagnation" and "inflation" to describe what seemed impossible in conventional economics.

Typically, high inflation correlates with full employment and economic expansion. However, in stagflation, this relationship breaks down. The measurement of growth through GDP shows weak or negative values, while prices continue to rise. This disconnection is precisely what makes it difficult to address this condition.

## The Dilemma of Economic Policies

Governments and central banks have tools to combat recession or inflation separately, but they act in opposite directions.

To reverse economic stagnation, central banks inject money into the economy and lower interest rates. This makes credit cheaper for businesses and consumers, stimulating spending and investment. The typical result is recovery and employment.

On the contrary, to curb inflation, they reduce the money supply and raise interest rates. With more expensive credit and scarce money, consumers spend less, demand falls, and prices moderate.

In stagflation, applying one strategy automatically worsens the other condition. This contradiction is what creates political entrapment.

## Why does stagflation arise?

### Incompatibility between fiscal and monetary policy

When the government raises taxes or reduces spending (restrictive fiscal policy) simultaneously with the central bank expanding money (expansive monetary policy), the effects are partially neutralized. Consumption falls due to lower income, but inflation rises due to excess money. Result: a weak economy with high prices.

### The end of the gold standard

Historically, currencies were backed by gold, which limited the issuance of money. After World War II, this system was abandoned in favor of fiat money (without physical backing). With no supply constraints, central banks can issue unlimited amounts, increasing inflationary risk.

### Supply cost shocks

When external factors trigger production costs, especially energy, two things happen. Producers raise prices (limited and expensive supply), and consumers reduce purchases (money absorbed by energy and fuel). Demand falls, production slows down, and prices keep rising.

## Economic Outlook for Overcoming Stagflation

Different economic schools propose different remedies:

**Monetarist approach:** Prioritize controlling inflation by reducing the money in circulation, temporarily accepting higher unemployment. Once inflation is controlled, apply subsequent stimuli for recovery.

**Supply-side Approach:** Invest in productive efficiency, subsidize key industries, and control energy costs. This increases production capacity without merely injecting money, simultaneously reducing prices and unemployment.

**Free market solution:** Let supply and demand balance naturally. Excess supply reduces prices, unemployment attracts cheap labor, and the economy self-corrects. The downside: this process takes years or decades.

## Impact on cryptocurrency markets

Stagflation creates a very specific context for digital assets:

**In the phase of inflation control:** Central banks raise interest rates to curb inflation. This causes investors to seek low-risk assets (bonds, deposits), abandoning cryptocurrencies and stocks. Bitcoin and other digital currencies often experience capital outflows.

**When growth falls:** Consumers and businesses retain cash for emergencies, reducing speculative purchases. Crypto markets suffer from lower demand and limited liquidity.

**Inflation Opportunity:** Once authorities control inflation, they typically expand money again (quantitative easing, low rates). During these periods, risk assets like Bitcoin and cryptocurrencies rebound. Many investors see Bitcoin as a hedge against future inflation due to its limited supply (21 million coins), functioning as a "digital store of value."

However, this hedging strategy using cryptos works better in the long term. In short terms during pure stagflation, liquidity pressure can dominate over the appeal as a store of value.

## Historical case: Oil crisis of 1973

In 1973, the OAPEC (Organization of Arab Petroleum Exporting Countries) imposed an oil embargo on several countries in response to the Yom Kippur War. The global oil supply collapsed, multiplying its price and generating shortages in global supply chains.

The United States and the United Kingdom responded by lowering interest rates to stimulate their economies. Logically, this should encourage growth. But with energy being a fundamental cost of consumption and production, inflation soared without real growth recovering. Result: classic stagflation of the 1970s.

## Conclusions

Stagflation presents a unique challenge because it combines two problems that typically do not coexist. The tools that solve one aggravate the other. For investors, especially in cryptocurrencies, it requires understanding the macroeconomic context: money supply, interest rates, supply-demand dynamics, and unemployment rate. Anticipating which phase of stagflation the economy is going through is key for investment decisions.