Quantitative easing is the Federal Reserve’s latest attempt to ignite low inflation.
While the U.S. central bank is undoubtedly among the most sophisticated in the world, the experience of Vietnam shows that once released, the forces of inflation can be difficult to maintain.
In response to a decrease in exports, the Vietnamese government chose to devalue its currency in late 2009. Intended to maintain employment at home, the move lowered the price of cheap exports from Vietnam, giving the country a competitive advantage in a deflationary environment.
A year later, economic activity increased. GDP in Vietnam rose by 6.8 percent, according to official government statistics. In some ways, the currency devaluation was a policy success. In 2009, GDP grew at only 5.3 percent, its slowest rate in more than 10 years.
Unfortunately, a cheaper currency contributed to double-digit inflation. The government reported that inflation increased 11.5 percent in 2010, in line with growth in money supply, which increased 13 percent. The government target for inflation is 3.5 percent.
The Fed’s QE2 is thought by some analysts to be a slightly veiled devaluation of the dollar. Money supply, measured by the Fed, has been growing, while the velocity of money has been decreasing. Velocity, in effect, shows how fast consumers are spending.
In the late 1990s, each dollar in circulation was spent an average of more than twice a year. This measure, basically GDP divided by money supply, has been slowing ever since. The decline recently reversed, and an increase in velocity would give the Fed room to slow the printing presses.
Unless spending picks up, it wouldn’t be surprising to see inflation matching the growth of the money supply.
Double-digit inflation isn't likely in the United States during the next year, but if the Fed succeeds, it could face that challenge one day.
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