Stagflation is a relatively rare phenomenon that may be associated with an economic recession. Stagflation contrasts with inflation along with economic growth, which occurs when prices rise along with the economy’s output.
An economic recession occurs when the economy does not grow fast enough to meet the needs of its people. Stagflation occurs when the economy fails to develop and is also characterized by a high rate of inflation. Stagflation can be seen as a paradox because these conditions usually do not coincide.
During stagflation, the economy grows so slowly that unemployment rises. Meanwhile, prices continue to rise as if companies are selling everything they can produce. There is less demand for goods and services, which can lead to greater unemployment.
In an economy with high inflation rates, individuals do not know how much capital they can spend in the future. Inflation makes it difficult to plan and invest in the present because no one knows what their income will be after a certain period of time. This causes more uncertainty and slower growth. Thus, stagflation is a combination of two words: recession and inflation.
One of the most relevant examples of stagflation was during the 1970s, when many advanced economies experienced slow economic growth, high unemployment, and soaring inflation due to global fuel shortages. Stagflation may also be caused by monetary or fiscal policy, as when the United States decoupled its dollar from the gold standard in the period in question.
What causes stagflation?
Stagflation can be caused by an increase in the cost of living that exceeds consumer demand or production levels or a decline in gross domestic product, which can occur when the government imposes austerity measures. There are several other causes of stagflation, including supply shocks and monetary policy errors.
A supply shock is an event that causes prices to rise without any change in aggregate demand or firms’ inventory. These traumas can be caused by human actions. For example, conflict between countries may lead to an increase in the price of oil or another essential component of the production process, which leads to cost-pull inflation, which is inflation caused by higher costs as a result of higher wages and raw materials.
Supply shocks can also include price increases due to natural disasters, which cause prices to rise. Simply put, a change in the production process leads to a decrease in the supply of goods or services, which leads to demand-pull inflation, which is a specific type of inflation caused by a supply deficiency.
Monetary policy errors refer to how central banks manage their country’s money supply. Suppose they save a lot of money for lending because of the low interest rates. In this case, interest rates will fall, causing inflationary pressure on consumers’ wages and prices. However, with very high interest rates, the decline in economic activity may also lead to stagflation.
How does stagflation affect the cryptocurrency markets?
Cryptocurrencies have not been around for a long time. Thus, there is not much data yet on whether cryptocurrency is a good investment during stagflation and whether stagflation is generally good or bad for the markets.
To understand whether cryptocurrency investments do well during stagflation, one can study how traditional markets behave during inflation or stagflation and why. Stagflation is naturally bad for traditional markets, and because cryptocurrency markets have a high correlation with general indices, this means that negative sentiment can seep into cryptocurrencies which are digital assets managed using cryptographic algorithms.
In general, investors who have their money in traditional instruments may be better prepared to weather periods of economic uncertainty than those who invest in cryptocurrencies that come with higher volatility. During an inflationary recession, there may be less demand for cryptocurrencies than usual.
Stagflation may also hurt cryptocurrency markets as it makes retail investors less interested in buying digital assets. After all, high inflation directly affects the amount of money people have to buy cryptocurrency, which is a riskier investment.
However, depending on the cryptocurrency investment strategy, one may choose to invest in these assets rather than traditional financial instruments. Cryptocurrencies run on a blockchain and are not tied to the monetary policy of any particular country like fiat currencies. When inflation rises in one country but not in another, investors can still benefit from gains made through cryptocurrency investments, even if their home currency loses value due to inflationary pressures.
Investors often look for a way to protect their wealth from stagflation, especially in countries like Venezuela or Argentina, where hyperinflation is occurring. Hyperinflation occurs when there is a rapid and uncontrollable increase in the prices of vital goods and services in the economy. Here is cryptoc