Stagflation: The simultaneity of economic decline and rising prices

Summary: Stagflation occurs when the economy faces rapid price increases (inflation), while production declines and unemployment rises. This is a taxing situation for policymakers, as traditional remedies for one phenomenon usually exacerbate the other.

Introduction: Stagflation as a Symptom of Political Conflicts

The tools for curbing economic growth and preventing inflation are completely contradictory. Increasing the money supply leads to expansion and a better employment rate, but also increases price rises. Conversely – by limiting the money supply and raising interest rates – price growth can be slowed down, but it threatens economic growth and raises unemployment.

When these two phenomena operate in parallel, stagflation occurs – a situation where no conventional policy can solve the problem without worsening the other.

What is stagflation and how does it relate to different economic theories?

Stagflation is a macroeconomic phenomenon that combines stagnation (lack or decline of economic growth) and inflation (rising prices). British politician Iain Macleod introduced this term in 1965 to describe an economy where low or negative economic growth and high unemployment occur alongside rapid increases in consumer prices.

Typically, these indicators behave in the opposite manner: rapid economic growth leads to inflation, while an economic downturn actually reduces inflation. Stagflation is an exception that presents policymakers with difficult choices.

Stagflation versus normal inflation processes

Under simpler inflation conditions, prices rise while the economy grows and people earn income. In the case of stagflation, price increases occur in the context of an economic downturn – consumers suffer from both rising prices and stagnant income.

Causes of Stagflation: When and Why Does It Develop?

Stagflation occurs when the purchasing power of a currency declines while the productivity of the economy decreases and the supply of goods and services suffers. Specific causes depend on the historical context, but economists have identified several more common patterns.

Fiscal and monetary policy contradictions

Central funding (, for example, the US Federal Reserve), controls the money supply, referred to as monetary policy. Governments directly influence the economy through tax and spending policies (fiscal policy). When these two forces act in opposition – for example, the government raises taxes (reducing consumer spending) while the central bank lowers interest rates (increasing the money supply) – the result can be stagflation. A government's increase in fiscal burden combined with the central bank's expansion of the money supply creates inflation but does not stimulate economic growth.

Effects of transition to fiat currency

Before World War II, the gold standard tied the currencies of most major economies to physical gold, which limited the money supply. The abandonment of the gold standard and the transition to fiat money gave central banks more flexibility, but also removed the natural constraints on the money supply. As a result, it became easier to increase the money supply, which in turn raised the risk of inflation.

Supply shocks and energy costs

Stagflation can also be triggered by a sharp rise in supply costs, especially disruptions in the energy sector (supply shock). When oil and energy prices spike, production costs rise, consumers suffer from fuel and transportation costs, and they have less money for other expenses. The combination of increased supply costs and simultaneously declining consumer demand leads to stagflation.

Solutions to the Challenges of Stagflation: Different Economic Theoretical Approaches

Economists have long debated how to address stagflation, as different schools of thought emphasize different priorities.

Monetarist approach: Controlling the money supply primary

Monetarists ( scientists who believe in the importance of controlling the money supply) argue that inflation must first be curbed. According to this strategy, the money supply should be significantly reduced, which lowers the overall spending level, puts downward pressure on prices, and halts inflation. Unfortunately, this approach does not promote economic growth and may actually worsen a recession in the short term.

Offer optimization: Reducing costs and efficiency

Other economists recommend focusing on increasing supply – reducing energy and production costs through investments and subsidies. When production costs fall, consumer prices also decrease, the economy is stimulated, and unemployment decreases. This approach attempts to address the root cause of stagflation, not just the symptoms.

Hope of the Free Market Doctrine

Some advocates of free trade believe that market mechanisms will resolve stagflation on their own if the government does not intervene. When prices are high, demand decreases, which lowers prices; in the case of labor shortages, wages rise and unemployment decreases. The problem is temporal: initiating this process can take years, leaving populations in a difficult economic situation.

Stagflation and Crypto Markets: Analysis of Complex Effects

The exact impact of stagflation on the cryptocurrency market depends on many variables, but some reliable predictions can be made.

Economic growth stagnation: Less money for investment

A slowly growing or declining economy reduces people's incomes and their ability to invest. Retail investors sell crypto and equity assets to obtain liquidity for daily expenses. Large investors and institutions are also reducing their risky positions, as they do not like an unstable economic environment.

Interest rate hikes as a depressant for the crypto market

When the government decides to curb inflation, the central bank usually raises interest rates. Higher interest rates make borrowing more expensive and tighten the money supply. Cryptocurrencies, which offer a high level of risk and potentially high returns, become less attractive when safe investments (, such as bank accounts ), already guarantee good interest rates. Therefore, the demand for crypto falls and prices go down.

Positive aspect: Increase in money supply and stimulation of growth

When the government has brought inflation under control, it usually tries to restore economic growth through quantitative easing and lowering interest rates – which increases the money supply. This scenario is generally more favorable for cryptocurrency markets, as a larger money supply and low interest rates drive investors towards riskier assets.

Bitcoin as an inflation-resistant hedge: Theory and reality

Many investors see Bitcoin as a hedge against rising inflation, as its supply is limited and cannot be increased. Theoretically, Bitcoin should increase in value during periods of rising inflation and maintain purchasing power. In practice, this strategy has worked during long-term inflation periods, especially when combined with economic growth or expansion.

During stagflation, Bitcoin remains caught between dubious outcomes – rising inflation could increase its price, but the lack of economic growth and rising interest rates push it down. There is also an increased correlation between the crypto and stock markets, which weakens Bitcoin's protective potential.

Historical example lesson: The 1973 oil crisis and stagflation

In 1973, the Organization of the Petroleum Exporting Countries (OPEC) imposed an oil embargo on many Western countries – in response to the support of Israel in the Yom Kippur War. Oil supply plummeted, prices soared, and global supply chains became unstable. The rise in consumer prices was significant.

The USA and the United Kingdom faced a decision: whether to raise interest rates and stop inflation ( but risk slowing down the economy ) or to keep interest rates lower and experiment with stimulating economic growth ( even though inflation would continue ). Many countries chose the latter path, increasing the money supply and lowering interest rates. The result was a long period of stagflation during which they would suffer from both rising prices and unemployment.

This historical experience shows how difficult stagflation becomes for policymakers and the tough choices it demands from them.

Summaries: Stagflation as a Test of Economic Strategy

Stagflation is a phenomenon that forces policymakers to face difficult choices – since inflation and economic decline typically move in opposite directions, they must choose which problem to prioritize. Each choice has negative consequences.

For investors, especially those involved with cryptocurrencies, stagflation requires careful analysis from a macroeconomic context – considering the level of money supply, the trajectory of interest rates, employment indicators, and the dynamics of global supply is essential. Stagflation is not just an economic concept – it is a real threat that actually robs from investors' portfolios.