Stagflation: understanding this paradoxical economic crisis

A Broken Economic Balance

When an economy is simultaneously faced with a decline in production, massive job losses, and a widespread increase in prices, it is experiencing what is known as stagflation. This phenomenon, whose definition of stagflation dates back to 1965 and the economist Iain Macleod, represents one of the greatest challenges for governments and central banks around the world.

Unlike classical economic cycles where growth is naturally accompanied by moderate inflation, stagflation creates a paradoxical situation: two inversely related evils converge in the same period. The usual policies to combat one inevitably worsen the other, thus creating a decision-making deadlock.

The mechanisms behind the phenomenon

Why are these two crises occurring together?

Stagflation generally emerges when several factors come together. First, a drastic reduction in the global supply of goods and services, particularly in strategic sectors such as energy. Then, contradictory monetary policy choices: while a central bank seeks to stimulate growth by massively injecting fiat money into the economy, a government may simultaneously cut public spending or increase taxes.

This situation has worsened since the abandonment of the gold standard after World War II. Without this regulatory mechanism, the expansion of the money supply no longer has a structural limit, facilitating speculative bubbles and inflationary cycles.

The structural causes

Supply shocks play a predominant role. When production costs rise sharply—especially through energy prices—companies pass these extra costs onto consumers. At the same time, these energy expenses reduce households' purchasing power, leading them to cut back on other purchases. The result: an economy that contracts despite persistent inflation.

Divergent Response Strategies

The monetarist approach

Monetarists believe that controlling the money supply is the key element. According to this school, gradually reducing interest rates slows down overall spending, thereby dampening demand and lowering prices. However, this strategy tends to deepen the short-term recession, causing significant social damage before growth resumes.

The vision of the offer

Other economists advocate for increasing production by reducing obstacles: subsidizing energy, investing in energy efficiency, and easing regulations. This approach aims to lower costs and therefore prices, while stimulating economic activity and employment.

Trust in the free market

A third school of thought believes that the intervention prolongs distortions. As consumers face unsustainable prices, they reduce their purchases, which ultimately leads to a natural decrease in inflation. The market also reallocates labor towards dynamic sectors. Nevertheless, this remedy requires patience and acceptance of massive difficulties for several years.

The Test of 1973: When Theory Becomes Reality

The oil embargo imposed by OPEC in 1973 is a perfect illustration of stagflation. Following the Yom Kippur War, the price of oil skyrocketed dramatically, creating shortages and logistical breakdowns. Inflation soared, particularly in the United States and the United Kingdom.

Central banks are lowering interest rates in an effort to revive growth. However, this stimulus cannot offset the oil shock: households, impoverished by energy costs, are not spending more. The result is a toxic combination of high inflation and stagnant economic growth.

Implications for cryptocurrency markets

Reduction of purchasing power

During stagflation, individual incomes stagnate or decrease while prices rise. Investors lose interest in speculative assets like cryptocurrencies to access readily available liquidity. Large institutional funds also reduce their exposure to high-risk segments.

Impact of government measures

To combat inflation, authorities generally raise interest rates, making safe investments more attractive and discouraging risky investments. Cryptocurrency, compared to government bonds, loses its appeal. Conversely, once inflation is under control, subsequent quantitative easing and rate cuts tend to stimulate digital assets.

Bitcoin as a hedge against inflation

Many investors see Bitcoin as a store of value in the face of monetary degradation. Its finite supply and immutable programming distinguish it from fiat currencies. Historically, those who accumulated bitcoins during inflationary periods have been able to preserve and then increase their wealth.

However, this hedging strategy shows its limits during prolonged stagflations, particularly due to the increasing correlation between cryptocurrencies and traditional stock markets. When stocks collapse under the weight of a failing economy, cryptocurrencies often experience the same pressures.

Conclusion: an economic puzzle without a perfect solution

The definition of stagflation summarizes the essence of the modern macroeconomic dilemma: how to simultaneously deal with negative growth and rising prices? The tools intended to combat one inevitably worsen the other.

Decision-makers must therefore adapt their response to the specific context, considering the money supply in circulation, the evolution of interest rates, the dynamics of supply and demand, and especially the actual adaptability of the population. No approach is universal, which explains why each stagflation produces its own contours and its own solutions.