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What is stagflation and how it affect market for cryptocurrencies?

12/11/2022
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A state of economic stagnation known as stagflation is characterized by inflation, high unemployment, and slow economic growth. This confluence is particularly challenging for economic policymakers to manage because trying to address one issue can make another worse. During the 1973–1975 recession, the phrase first appeared.

What is stagflation?

A period of slow economic growth, a high unemployment rate, and inflation are all signs of a stagflation cycle. Due to the potential for aggravating one of the factors, economic policymakers find this combination particularly challenging to manage.  The term was revived in the United States during the oil crisis of the 1970s, which led to a recession with five quarters in a row of negative GDP growth. From 1973 to 1974, inflation doubled and reached double digits. By May 1975, unemployment had reached 9%.

A misery index was used to illustrate the effects of stagflation. This index, which was just the inflation rate plus the unemployment rate added together, monitored how stagflation actually affected a country’s citizens.

History of Stagflation

It was once thought that stagflation was impossible. It was excluded from their models by the economic theories that predominated in academic and policy circles for much of the 20th century. In particular, macroeconomic policy was portrayed as a trade-off between unemployment and inflation in the economic theory of the Phillips Curve, which emerged in the context of Keynesian economics.

Economic experts became concerned about the risks of deflation as a result of the Great Depression and the rise of Keynesian economics, and they asserted that most policies intended to lower inflation typically tend to increase unemployment while those intended to lower unemployment tend to raise inflation.

Even during times of sluggish or negative economic growth, inflation has shown to be persistent. Every declared recession in the United States over the past 50 years has been accompanied by a constant, yearly increase in consumer price levels.

What Causes Stagflation?

The causes of stagflation are a hotly contested topic among economists because, prior to the stagflation-fueled 1970s, the Phillips Curve supported the idea that unemployment and inflation were inversely related. However, economists have put forth a variety of hypotheses as to why stagflation occurs.

Supply Shock

According to the supply shock theory, a sudden drop in the supply of a good or service leads to stagflation. Price increases as a result of this usually result in lower profit margins for most businesses and slower economic growth.

Bad monetary policies

According to the “bad policy theory,” poor economic decisions frequently lead to stagflation. The government and central bank frequently make poor decisions when attempting to control the economy. For instance, following the Employment Act of 1946, the U.S. was prior to the 1970s focused on maximizing employment throughout their economy, which unintentionally increased inflation and negatively impacted employment and growth.

The Nixon Shock, which saw the dollar devalued and wage and price freezes enacted, is evidence that government policies regulating the economy can also have an impact. Ultimately, because interventions to support their goals of price stability, low unemployment, and economic growth can conflict, central banks and legislators struggle with how to combat stagflation

 

 

Differential Accumulation

The differential accumulation explanation of stagflation is a theory put forth by economists Shimshon Bichler and Jonathan Nitzan that contends there is a connection between mergers and acquisitions, stagflation, and globalization. They contend, in a manner similar to the supply shock theory, that differential accumulation propels mergers and acquisitions, which in turn concentrates control over the ability to control the supply of commodities and accumulated capital in a smaller number of hands and raises the risk of stagflation.

Demand-Pull

The demand-pull stagflation theory, put forth by economist Eduardo Loyo. It contends that stagflation can arise solely from monetary shocks without the requirement of a supply-related shock. This happens when monetary tightening regulations are implemented by governments, such as increasing the federal interest rate or reducing the money supply.

Cost-Push

According to the cost-push inflation theory, supply-side inflation is a major driver of stagflation. In this case, rising prices cause unemployment because they reduce profit margins for businesses, resulting in lower economic output. Tariffs, wage increases, and labor shortages can all have an effect on supply-side inflation.

What effect does it have on cryptocurrency markets?

To understand whether cryptocurrency investments perform well during stagflation, consider how traditional markets behave and why during inflation. Stagflation is inherently bad for traditional markets. Because cryptocurrency markets have a high correlation with general indexes, negative sentiment can spread to cryptocurrencies.

In general, traditional investors may be more willing to ride out periods of economic uncertainty than those who invest in cryptocurrencies, which are associated with higher volatility. As a result, there may be less demand for cryptocurrencies during stagflation than usual.

 

 

It may harm cryptocurrency

It may also harm cryptocurrency markets by discouraging retail investors from purchasing digital assets. After all, high inflation directly affects how much money people have to buy cryptocurrency. However, it is regarded as a riskier investment.

Investors frequently look for ways to safeguard their wealth from stagflation. Particularly in nations where hyperinflation occurs, such as Venezuela or Argentina.When the cost of essential goods and services in an economy rises quickly and uncontrollably. It is said to be experiencing hyperinflation. Here, cryptocurrency investments are advantageous because they offer an alternative payment method and offer protection from hyperinflation during stagflation. Some people may decide to divert some of their savings into Bitcoin in order to avoid hyperinflation.

Conclusion

It cannot be cured completely. According to economists, productivity needs to be raised to a level where it will result in higher growth. But it’s completed without causing more inflation. As a result, it would be possible to tighten monetary policy and control the inflationary component of stagflation. The key to preventing stagflation is for economic policymakers to be extremely proactive in doing so.

Also Read: What Is Dollar-Cost Averaging And How Does DCA Works?

Source: https://coingape.com/education/what-is-stagflation-and-how-it-affect-market-for-cryptocurrencies/