In late 2008, in order to boost the American economy and help mitigate the effects of the Great Recession, the Federal Reserve adopted an expansionary monetary policy, enlarging its balance sheet. The central bank employed various strategies to combat the strong deflationary pressures that surged after the 2008 meltdown.
First, it slashed interest rates to nearly zero percent and has held them there ever since. It then utilized quantitative easing (QE) to buy financial assets, like government bonds, with the purpose of increasing the liquidity of member banks’ reserves and keeping interest rates low.
With quantitative easing, the Fed intended for the “excess” liquidity to push up asset prices, probably hoping that the “wealth effect” of higher asset prices would spur economic activity in the United States.1 While experts still debate the success of the Fed’s approach domestically, the policy has had noticeable international repercussions.
More Dollars Create High Inflation for Others
In the period 2009 to 2012, the abundance of dollars coupled with low U.S. interest rates caused capital to flow overseas into more dynamic markets for investment opportunities.2 To absorb this flood of investment dollars, other countries had to expand their money supply, thereby creating inflation.
In 2009 and 2010, emerging market asset bubbles began to form due to global carry trades in which investors borrowed capital from low-interest rate countries, particularly the United States. 3 Investors then channeled this capital into higher-yielding investments in those emerging markets, which were less prone to deflation.