Stagflation: when the economy is characterized by chaos

Introduction: a paradox that puzzles economists

It is a rare but critically important phenomenon when the economy simultaneously suffers from stagnation and inflation. At first glance, this seems impossible – usually, a simple principle operates in the economy: when production grows, unemployment falls, and prices stabilize. However, history has shown that there are periods when these rules do not apply.

The term “stagflation” was introduced in 1965 by British politician Ian Macleod, combining the words “stagnation” and “inflation”. This concept describes a macroeconomic crisis where a country simultaneously experiences minimal or negative GDP growth, high unemployment, and uncontrollable rises in the prices of goods and services. What makes stagflation so complicated? Traditional means of combating one problem inevitably worsen the other.

How stagflation arises is characterized by a conflict of policies

Central banks and governments have two main tools at their disposal to influence the economy. The first is monetary policy, conducted by the central bank (, for example, the Federal Reserve System of the USA ), through managing the money supply and interest rates. The second is the fiscal policy of the government, which regulates spending and taxation.

When the economy behaves “normally”, these tools complement each other. But when they come into conflict, an avalanche of problems arises. Suppose the government raises taxes to cut household spending and fight inflation. At the same time, the central bank is conducting quantitative easing – printing money and lowering interest rates. The result: the economy declines due to government measures, but the money supply swells, keeping inflation at a high level. Here you have stagflation characterized by this paradoxical combination.

The cause of the change: from the gold standard to fiat money

The historical turning point in 1944 at the Bretton Woods Conference, and especially its final conclusion in 1971, laid the foundation for the possibility of stagflation. Before this, most countries pegged their currencies to gold – this guaranteed that central banks could not print money without limit. The gold standard was a natural constraint on inflation.

When the world switched to fiat currency – money without physical backing – central banks gained a dangerous freedom. They could now control the economy more flexibly, but this also opened the door to unpredictable inflation. It is this system that created the conditions for the parallel existence of economic stagnation and rising prices.

Energy Shock as a Trigger

However, monetary policy is not the only reason. The real world corrects the theory. The most striking example is the oil crisis of 1973. The Organization of Arab Petroleum Exporting Countries (OPEC) declared an oil embargo, which was a reaction to the support of Israel in the conflict. The result was catastrophic: oil prices quadrupled in a few months.

This led to a shortage of energy resources, which delayed production, and prices for all goods – from food to textiles – surged sharply. Companies could not produce cheaply, consumers had no money for purchases, and inflation soared. The central banks of the US and the UK tried to stimulate growth by lowering interest rates, but this only fueled inflation. The result: Western countries fell into stagflation for many years.

What economists do

There are three main schools of thought regarding the fight against stagflation.

Monetarists believe that the priority is to suppress inflation. They recommend sharply reducing the money supply and raising interest rates. This is painful for the economy, but according to their logic, it is necessary. When inflation falls, it will be possible to gradually ease monetary policy to stimulate growth.

Supply-side economists foresee a different path. Instead of cutting money, they suggest increasing the productive capacity of the economy: investments in technology, subsidies for producers, and price controls on energy resources. If supply increases, prices will fall, and growth will resume.

Libertarians and free market advocates recommend… doing nothing. They believe that the market will balance itself: when prices rise, demand falls, and the market finds equilibrium. However, this strategy requires the political will to endure years of depression and unemployment.

Stagflation and Crypto: An Investment Dilemma

For cryptocurrency investors, stagflation is not just an abstract economic concept; it is a real threat to the portfolio.

During periods of economic stagnation, people have less disposable money. Retail investors, who usually invest in Bitcoin and other cryptocurrencies, are forced to sell assets to cover expenses for food, utilities, and transportation. Large investors and corporations are also reducing positions in high-risk assets, including crypto.

When the central bank raises interest rates to curb inflation, cryptocurrencies become less attractive. People shift their money to bank deposits with higher yields. Liquidity in the crypto market dries up, and prices fall.

But there is also a positive scenario. Many view Bitcoin as a hedge against inflation – a kind of “digital gold”. Over long time horizons of ( years and decades), Bitcoin has indeed demonstrated the ability to preserve and increase value during inflationary periods, thanks to its limited supply of (21 million coins). However, in the short term, especially during acute stagflation, this strategy may not work – crypto often falls in sync with the stock markets.

Conclusion: why it matters

Stagflation remains one of the most challenging issues for the modern economy, as traditional management tools do not yield clear results. Attempts to curb inflation lead to recession, while attempts to stimulate growth ignite prices. There is no universal recipe.

For cryptocurrency investors, traders, and ordinary people, understanding the mechanisms of stagflation is the key to adaptation. What worked yesterday may not work tomorrow. Flexibility, diversification, and a long-term perspective are the three pillars of strategy in times of economic instability.