## Stagflation: When the Economy is in Double Trouble

**TL;DR** Stagflation occurs when the economy experiences high inflation along with negative growth and rising unemployment—a combination that makes it difficult for the government to control it because solutions to one problem may worsen the other.

## From Oil to Digital Money: Stagflation Hits the Market

In 1973, the world experienced an energy shock. The oil embargo from OPEC caused commodity prices to soar drastically. Western countries like the US and the UK then cut interest rates to stimulate growth. This strategy sounded reasonable, but the reality was different. Because energy is a large part of consumer spending, cutting interest rates was not enough to drive significant growth. The result: high inflation met with a stagnant economy. This is stagflation—the term first used in 1965 by British politician Iain Macleod.

At that time, economists were shocked. Conventional theory states that high unemployment and positive growth usually go hand in hand with inflation. But stagflation changed the game: two economic crises came at once without simple solutions.

## Stagflation Explained: Definition and Mechanism

Stagflation is a unique combination of **economic stagnation** ( minimal or negative growth ) and **inflation** ( sustained price increases ). Its characteristics include:

- Gross Domestic Product (GDP) does not grow or shrink
- The unemployment rate remains high
- Consumer purchasing power is declining due to rising prices.

The difference between stagflation and regular inflation is the context. Pure inflation often occurs when the economy is growing—high demand pushes prices up. Stagflation is different: the economy is pulled down while prices continue to soar. This is the worst combination for investors and consumers.

## Why is Stagflation Difficult to Overcome?

The problem lies in two opposing policy instruments:

**To tackle the recession**, the central bank increases the money supply (quantitative easing) and lowers interest rates. Loans become cheaper, consumers spend more, the economy grows. A classic solution that often works.

**To tackle inflation**, the central bank actually reduces the money supply and raises interest rates. Loans become expensive, consumption decreases, demand drops, and inflation slows down. It's also a classic solution.

But during stagflation, both policies clash. If the central bank lowers interest rates for growth, inflation will surge. If it raises interest rates for inflation, growth will halt. That is why policymakers face a dilemma: choose to prioritize growth or let inflation swell?

## Root Causes of Stagflation

Stagflation is rare, but when it occurs, there are usually several triggers:

### Energy Supply Shock
A drastic increase in production costs—especially energy and oil—can trigger stagflation. When input prices soar, producers raise product prices. Consumers with stagnant incomes are forced to cut back on purchases. Inflation rises, demand falls, the economy stagnates.

### Monetary and Fiscal Policy in Conflict
The central bank conducts monetary policy (money supply control), while the government implements fiscal policy (taxation and spending). If both are in opposing directions—for example, the government raises taxes (reducing consumer spending) while the central bank pumps liquidity (increasing the money supply)—the result can be stagflation.

### Fiat Currency System
Before World War II, most countries pegged their currencies to gold (gold standard). This system limited the money supply. After the war, the gold standard was abandoned in favor of fiat currency without restrictions. This flexibility made it easier for central banks to control the economy, but it also opened the risk of uncontrolled inflation—one of the triggers of stagflation.

## Three Economic Streams, Three Different Solutions

Economists do not agree on how to address stagflation:

**Monetary School** believes that inflation is the main enemy. They will reduce the money supply first, even if growth slows down. With demand falling, prices will stop rising. Growth can then be stimulated through easing policies. Weakness: the transition period will feel painful.

**Supply-Side Economists** focus on increasing the aggregate supply of the economy. They advocate for efficiency investments, energy price controls, and production subsidies to lower costs. With supply increasing and costs decreasing, inflation eases without sacrificing growth.

**Free Market School** believes that the market will self-correct. Consumers cannot buy when prices are high, demand will fall, and inflation will decrease by itself. The market will also allocate labor efficiently. But this solution requires years and society must endure difficult living conditions during the process.

## Stagflation and the Crypto Market: Layered Impacts

The relationship between stagflation and digital assets is complex and context-dependent. However, there are patterns that can be observed:

### Retail Liquidity Reduction
When economic growth slows or becomes negative, consumer incomes stagnate or decline. Retail investors will reduce allocations to high-risk assets like crypto. Many are forced to sell for daily needs. Demand for Bitcoin and other crypto assets tends to decrease during the negative growth phase of stagflation.

### Central Bank Response: Two-Phase Cycle
Typically, the government will prioritize addressing inflation first by raising interest rates and reducing the money supply. This phase is not favorable for crypto as liquidity decreases, and investors seek safe havens. Bitcoin and crypto will experience selling pressure.

After inflation is under control, the government will stimulate growth through quantitative easing and interest rate cuts. This phase is relatively better for crypto as liquidity increases again.

### Bitcoin as an Inflation Hedge: Myth or Fact?
Many investors see Bitcoin as a hedge against high inflation. The logic is: fiat money with no interest will continue to lose value, while Bitcoin with a limited supply of (21 million coins) will maintain purchasing power. Historically, this strategy has worked for those who accumulated Bitcoin over many years during periods of inflation and normal growth.

However, during that stagflation, it is different. Although inflation is high, negative economic growth will reduce investor risk appetite. They will sell risky assets first and then look for hedges. Additionally, the correlation between crypto and the stock market increases in stressed market conditions, making Bitcoin not function as a perfect diversification.

## Conclusion: Stagflation is an Economic Puzzle

Stagflation presents a unique paradox in macroeconomics. The tool to address recession (monetary stimulus) actually worsens inflation. The tool to address inflation (monetary restriction) actually hinders growth. This is why policymakers feel trapped.

For investors, especially in the crypto market, understanding stagflation is important for long-term hedging strategies. As taught by the 1973 crisis, stagflation is not just an abstract macroeconomic problem—its impacts are real and touch the portfolio of every investor.