## The Economy in Ambush: How to Understand the Phenomenon of Stagflation

The concept of **stagflation** describes one of the most difficult macroeconomic situations – when the economy simultaneously experiences stagnation, rising prices, and high unemployment. This phenomenon occurs rarely, but when it does, it creates a real headache for governments and central banks. Why does this happen and how does it affect the markets, including crypto? Let's take a closer look.

## How does such a controversial situation arise?

At first glance, stagflation seems like a paradox. Typically, economists have tools to combat economic downturns and separately to curb inflation. But when both phenomena occur simultaneously, classical remedies fail.

Governments traditionally try to revive the economy by increasing the money supply, lowering taxes, and obtaining loans. Central banks reduce interest rates, making borrowing cheaper. Theoretically, this should create jobs and encourage consumption.

In contrast, when it is necessary to curb inflation, the opposite tactic is employed: reducing the money supply, raising interest rates, and limiting spending. This freezes the economy but lowers prices.

The problem arises when the **monetary policy** of the central bank and the **fiscal policy** of the government begin to work in opposite directions. When one stimulates while the other restricts, it results in a mix that generates both inflation and stagnation.

## Where did the very idea of stagflation come from?

The term was proposed by British politician Ian Macleod in 1965. The name is a mixture of the words "stagnation" (застій) and "inflation" (інфляція). But the world truly witnessed a large-scale demonstration of the phenomenon in 1973.

### The Oil Crisis of 1973: How the World Fell into Stagflation

The Organization of Arab Oil Exporting Countries (OPEC) announced an embargo on oil supplies to countries that supported Israel on Judgment Day. The result was disastrous: energy prices soared, production became more expensive, and food prices increased. Inflation in the US and Europe reached unprecedented levels for these regions.

In response, the central banks of Ukraine and other countries lowered interest rates to try to support the economy. However, due to the energy supply shortage, the economy still slowed down. The outcome was the worst: high prices + low employment + slow GDP growth. The classic formula of stagflation.

## Why is it difficult to control?

The usual correlation between unemployment and inflation is defective in conditions of stagflation. The Phillips curve typically shows an inverse relationship: lower unemployment = higher inflation. However, during stagflation, both indicators rise simultaneously.

The main factors leading to such a situation:

**Clash of Economic Policies.** The government raises taxes and cuts spending, while the central bank simultaneously prints money and lowers interest rates. One factor slows down demand, while the other heats it up. The result is inflation without growth.

**Energy price surge.** A sudden increase in the prices of oil, gas, or electricity instantly raises production costs. Companies raise prices, consumers spend more on utilities, and buy fewer goods. The economy slows down, but prices do not fall.

**Transition to fiat currencies.** When the world abandoned the gold standard after World War II and switched to paper money, central banks gained greater freedom. They could print money without restrictions – but this created the risk of irresponsible expansion of the money supply and hyperinflation.

## How are economists trying to fight?

Different schools of economic thought offer different outputs.

**Monetarists** ( followers of Milton Friedman) insist on strict control of the money supply. Their logic: first suppress price inflation by reducing money, even if the economy remains hot. Then, when inflation passes, the money supply can be gradually expanded.

**Supply-side economists** believe that it is necessary to increase production. They propose subsidies for businesses, price controls on energy resources, and investments in efficiency. More goods = lower prices = consumers buy more = the economy grows.

**Libertarians** insist on non-intervention. In their view, the free market will self-regulate supply and demand. Consumers will stop buying expensive goods, demand will fall, and prices will drop. Workers will sometimes move to more promising sectors. But such "treatment" requires years or decades of low living standards – hence Keynes's phrase: "in the long run we are all dead".

## How does stagflation pressure crypto?

When stagflation hits the economy, crypto goes through a difficult period.

**Initially – extreme cutbacks.** When people lose income, they free up cash from risky assets. Stocks, crypto, stock options – all of these are sold to have fiat for everyday expenses. Bitcoin and altcoins are falling along with the stock markets.

**Then – a period of high interest rates.** When central banks raise interest rates to curb inflation, loans become more expensive. In this climate, people deposit money in banks (the interest is attractive!) instead of investing in crypto. Demand for digital assets falls, and so do prices.

**Then – a turn.** As soon as inflation is brought under control, central banks begin to lower rates and expand the money supply (quantitative easing). There is a lot of money in the system, bank deposits yield little – people are looking for other opportunities. Crypto gets a breather.

Many investors view Bitcoin as a hedge against inflation. Its supply is limited to 21 million coins, so in the context of infinite printing of hryvnias or dollars, BTC should theoretically increase in value. This works, but over the long term – years and decades of accumulation. In the short term, especially during stagflation, crypto fluctuates along with risky assets.

## Conclusion: why is stagflation so dangerous?

Stagflation is a macroeconomic "rare disease" where treatment for one problem exacerbates another. Conventional policy tools lose effectiveness. Politicians and central bankers are in a bind: should they save the economy from stagnation or curb price spirals?

Understanding the causes of stagflation is a huge problem for macroeconomists, as it forces a re-examination of established models and consideration of the complex interactions between the money supply, interest rates, demand, supply, employment levels, and global factors (such as energy prices). It deliberately appears during crisis periods, and each new wave of stagflation compels economists to learn anew.