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As the Amount of Money in Circulation Increases Rapidly, How Does the Fed Prevent Hyperinflation?

Name: Doug Smith
City & State: Rochester, Ind.

Inflation in Somaliland; tristam sparks via Flickr

Question: If the Fed and Treasury have increased the amount of money in circulation by $1.6 trillion in an effort to stave off deflation in the near term, how does the Fed take this money back out of circulation to prevent inflation once the economy eventually ramps up again?

If I understand you correctly, to date, they have more than doubled the amount of dollars in circulation over last year. How realistic is it that the Fed can react quickly enough to stave off hyperinflation given the magnitude of this increase?

Paul Solman: That's the $64 trillion dollar question. (Actually, "64" is wild hyperbole but that's the convention, ever since the CBS radio show "The $64 Question," hosted by - get this - Jack Paar in 1950 and 1951. Then came TV's "$64,000 Question.")

Back to the question. The Fed typically giveth and taketh away. Of late, it has tried to flood the financial system with its electronic cash by buying up all sorts of toxic assets. If it wants to sop up that cash, it can sell the assets when times get good. The fear, of course, is that if it starts selling, times will turn bad once again. That's why Alan Greenspan maintained an easy money policy in the late 1990s, because of fears for the world economy (Mexico crisis; Russia crisis). And why he did so again after the dot.com collapse and 9/11.

-- Posted April 8, 2009 | Comments ( ) | Permalink