Stagflation is an economic phenomenon that combines slow economic growth and rising living costs. For several decades, economists have argued that stagflation was impossible due to the laws that dominate the economic landscape. However, economic shocks throughout the last century have shown that stagflation genuinely threatens the global economy. The consumer price index (CPI), which measures the average price change over time, has increased 7.5% in the past year. This marks the highest inflation rise since 1982. In addition, annual growth is grinding to a halt in economies large and small. As such, stagflation is becoming a popular topic of conversation among investors and economists. So, if you’re one of the many people wondering, “what is stagflation and how does it work?” - read on!

In this article, we’re going to explore the concept of stagflation. We’ll take a look at inflation, economic stagnation, and the broader socio-economic impacts that occur when these economic states coexist. Furthermore, we’ll address some of the most common questions around stagflation, such as, “what is stagflation?” and “how does stagflation affect the crypto markets?”. Also, we explore some of the tough decisions policymakers face globally due to global supply shortages and economic shocks.

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What is Economic Stagnation?

Economic stagnation is when an economy experiences a sustained period of little to no growth. The consensus among economists is that anything below 2% annual growth constitutes stagnation. Furthermore, what characterizes stagnation is low economic output, high unemployment, and an increase in part-time employment. Some periods of stagnation are short-term, while others form part of a broader economic condition. Also, stagnation can occur within specific industries.

Slow economic growth is illustrated in our What is Stagnation article using a city on top of a snail.

When an economy stagnates, wages don’t rise, and stock markets tend to suffer. Stagnation can happen to any economy, regardless of how advanced it is. There are several causes of stagnation. Often, economic shock plays a key role. When economies suffer as a result of war, natural disasters, or supply chain shortages, economic output tends to stagnate.

What is Inflation?

In economics, the term “inflation” refers to a reduction in the purchasing power of a currency. Inflation is characterized as a fall in purchasing power. For example, when the cost of goods and services appears to increase, or the amount of money they once cost is no longer enough, consumers need more of any unit of currency to purchase the same goods and services.

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Effectively, inflation causes currencies to lose their purchasing power. Conversely, deflation causes currencies to gain purchasing power as prices decline. The aim of inflation is to measure the impact of price changes throughout a basket of goods and services. This includes healthcare, commodities, energy, food, labor, and entertainment.

Declining purchasing power results in a decline in disposable income. People are less likely to go out and spend. Plus, they tend to have less money to invest. As a result, economic growth slows down when the cost of living increases for the majority of the population. Economists agree that long-term inflation occurs when an increase in money supply exceeds the economic growth of a nation.

Different Types of Inflation

Broadly speaking, there are three types of inflation: demand-pull inflation, cost-push inflation, and built-in inflation. Demand-pull inflation occurs when supply shortages cause upward pressure on prices. Cost-pull inflation is characterized by an increase in the prices of products and services as a result of the rising cost of wages and raw materials. Subsequently, higher production costs result in a reduction in economic output.

Stagflation, what is it? Boxer punches a stack of coins.

Built-in inflation refers to the demand for wage increases in the labor markets to meet the rising cost of living. This often results in businesses increasing the prices of goods and services to offset increasing wage costs. Inflation affects people in different ways. For business owners and employees, inflation has noticeable negative effects. However, inflation often results in an increase in the value of assets such as stocks, real estate, and commodities.

The Consumer Price Index (CPI)

The consumer price index (CPI) measures the weighted average cost of basic goods and services. This includes everyday essentials such as food, clothing, and healthcare. Also, the CPI calculates the average prices of a basket of consumer goods and services to assess the relative cost of living and the impact of various price changes. Accordingly, it is one of the most widely used measures for analyzing inflation and deflation. Plus, the CPI helps economists to understand the buying habits of consumers and determine gross domestic product (GDP).

The consumer price index is important to look at when exploring what stagflation is.

In addition, the CPI helps investors to adjust returns calculations for inflation. However, this measure is somewhat controversial. Some economists believe that the CPI is an inappropriate measure for inflation. This is because of the lack of consensus around the CPI overstating or understating data. 

What is Stagflation?

Now that we understand the concepts of stagnation and inflation, let’s consider the question, “what is stagflation?”. Economic stagflation combines stagnation and inflation. The term “stagflation” was coined in the 1960s by UK politician Iain Macleod. One of the best examples of stagflation is during the 1970s. During this period, several developed economies experienced slow economic growth and high unemployment (stagnation), coupled with rising prices (inflation) in the aftermath of global fuel shortages. During this period, unemployment in the US was at record levels. Also, rising oil prices and declining economic output resulted in a recessionary period of five consecutive quarters of negative gross domestic product (GDP) growth.

What is stagflation chart with earnings and economic growth as indicators.

Furthermore, stagflation paved the way for the misery index. The misery index measures the degree of economic distress stagflation causes and how it affects people’s well-being. This is achieved by combining the current inflation rate and unemployment rate. However, the concept of stagflation was largely dismissed by academics until the 1960s. Economic theories and models of the time maintained that unemployment and inflation were mutually exclusive in macroeconomic policy.

Keynesian theories of the time suggested that any attempts to reduce inflation tended to make life more challenging for the unemployed. Also, the same theories argued that policies aiming to alleviate unemployment tended to cause inflation to rise. However, real-world data from the past century shows this not to be the case. Also, the advent of stagflation serves as a stark reminder of how widely accepted economic theories often overlook the broader effects of economic policy prescriptions.

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What Causes Stagflation?

Several theories exist as to why stagflation occurs. One such theory is that a sudden increase in oil prices and the subsequent decline in production cause the cost of goods and services to increase and unemployment to spike. Also, some economists agree that stagflation occurs as a result of bad economic policies, such as when US President Nixon decided to take the US dollar off the gold standard.

Despite the consensus around them, these theories often fail to explain why stagflation occurs. However, what appears to be clear is that an expanding money supply and supply shortages contribute significantly to economic stagflation. Stagflation is an undesirable economic phenomenon because it contradicts traditional economic principles. For example, economists expect slow economic growth to coincide with rising unemployment but not with rising prices. As a result, rising unemployment leads to lower consumer purchasing power.

Experts agree that stagflation is an undesirable state for any economy. Stagflation presents a series of challenging economic decisions for policymakers globally. Trying to stimulate growth while simultaneously avoiding tax rises and attempting to alleviate a cost of living crisis leaves few options on the table beyond printing more money. With that said, increasing the money supply is only a temporary solution to a much greater issue.

What is Stagflation Doing to the Crypto Markets?

Stagflation is historically bad for stocks and equities. As the crypto markets have a high correlation with stocks, this negative sentiment tends to bleed into the crypto markets. War and supply shortages are causing a global slump in almost every market. During periods of stagflation, investors tend to hedge against economic downturns. Traditionally, this means investing in hard assets such as gold and silver. Some experts predict that stagflation could be a catalyst for Bitcoin and crypto adoption. In particular, Bitcoin has many of the same properties as gold. Accordingly, investors may look to Bitcoin as a way of preserving their purchasing power.

Furthermore, some economists believe that stagflation could cause the crypto markets to decouple from equity markets. In particular, if marginal gains decline further in the stock markets, crypto could seem like a viable alternative. Despite this possibility, the reality is that stagflation is having a negative impact on the crypto markets. However, as Bitcoin liquidity dries up on exchanges, the price could soon become volatile.

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How is Stagflation Fixed?

Stagflation is an economic phenomenon affecting nations of all sizes and stages of development. Economists agree that there is no single solution for stagflation. However, the consensus suggests that an increase in productivity without inflation could help shift monetary policies to assist in quelling inflation. Unfortunately, this theory is still unproven and is yet to be put into practice.

Addressing stagflation involves a fine balance between the increasing financial hardships of citizens and businesses while creating dynamic policies to hedge against future supply shortages. If policymakers can simultaneously stimulate economies and lower the cost of living for consumers, it could help to reduce stagflation. However, some countries are so consumed with addressing immediate economic and social problems that creating a long-term strategy is as straightforward as it might seem.

Moreover, tackling stagflation requires output to grow at a healthy pace so that businesses can steadily create new jobs to reduce unemployment. Also, prices must stay relatively stable to ensure people have enough money to stimulate the economy by going out and spending.

What is Stagflation? - Summary 

The ripple effects of stagflation can be felt globally in equities and asset markets. The crypto market is no exception to this. However, stagflation could present an opportunity for crypto to decouple from stocks if investors fail to turn a profit in traditional markets. If this turns out to be the case, stagflation could prompt traditional investors to consider cryptocurrencies as an alternative to unyielding stocks.

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