Sometimes it is worthwhile to try to understand the madness of Zimbabwe Ben and his merry criminals at the Federal Reserve. During the last few months, members of the FOMC have argued that inflation is too low and that they must print money to increase inflation to an "acceptable rate". To the average layman this statement is absurd, after all, low inflation is a good thing. Why on earth would the Fed openly state they want higher inflation?
Below is a chart which compares Core inflation in the US and Japan-post bubble. So far, US inflation has tracked Japan on the way down, despite money printing by the Federal Reserve and the 2009 stimulus package. This is why the Fed is so eager to initiate QE 2. They see these parallels and want to avoid Japan's deflationary spiral at all costs. To the Fed, low inflation signals QE 1's failure and increases the risk that the US may be falling into the dreaded liquidity trap where monetary policy is rendered ineffective.
Click chart for larger image.
Chart Source: Economistsview
Personally, I do not see the Japan scenario as a likely outcome. The main reason is demographics. The major determinant of Japan's deflation was a declining population. This resulted in a continuous reduction in demand for goods and services. However, in the US we have an ever increasing population, which leads to a continual increase in demand for goods and services. It is hard to have a period of prolonged deflation when there are more and more people entering the economy every year. Regardless of economic conditions people need a certain amount of stuff to live and more people need more stuff. The US economy is not set up for deflation in the long-term.
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