The Bank of Japan is just now beginning a new monetary stimulus plan in the hopes of moving the inflation rate back into positive territory, with the target at two percent. However, some analysts question the possibility of reaching the target inflation rate over the next couple years, even with this monetary stimulus plan. (Source: Fujioka, T., et al., “Bank of Japan Sees Inflation Nearing Target in 2015: Economy,” Bloomberg, April 26, 2013.)

This aggressive monetary stimulus package has driven the yen weaker, benefiting export-oriented companies; however, while the general inflation rate is low, prices for imports such as energy will continue to rise as the currency declines. Additionally, the monetary stimulus program to drive up the inflation rate will have an impact on property prices and will raise rent levels.

However, monetary stimulus is not enough to gain traction and increase the inflation rate. Japan needs structural reforms to its business sector to encourage expansion and growth. Psychologically, the average Japanese citizen has been used to price declines for many years—this mentality will be hard to change. As an example, the latest report showed that TV prices fell by 19% from last year. (Source: Ibid.)

In America, we’ve had monetary stimulus for quite a while, yet the inflation rate is still quite low, below the targeted level. In March, the consumer price index dropped by 0.2% versus a year ago for all items, seasonally adjusted—unadjusted, consumer prices increased by 1.5% in March versus a year ago. (Source: U.S. Bureau of Labor Statistics, April 16, 2013.)

The reason we don’t see a higher inflation rate even with a large level of monetary stimulus is because the velocity of money is at historically low levels. In fact, the velocity of money has been declining, pulling down gross domestic product (GDP) growth and the inflation rate.

However, at some point, the velocity of money will hit a bottom and, at that point, monetary stimulus will have an impact on the inflation rate. Even though the bank is printing money now, it won’t have an immediate effect, as it takes time for people’s mindsets to change; once something is ingrained, it is extremely difficult to shift.

Looking backward is easy, and it’s clear that monetary stimulus has had a limited effect on the inflation rate for many countries around the world, especially Japan, which has suffered from outright deflation.

The real question: will central banks begin reducing monetary stimulus before the inflation rate gets too high? Historically, central banks have been notoriously late in reducing monetary stimulus. This is what led to the housing bubble in America during the last decade.

The longer such an aggressive monetary stimulus is pushed, the greater the danger for both a higher inflation rate and bubbles occurring in certain segments of the economy and financial markets.

This is the reason why I believe we’re seeing physical gold continue to be accumulated by the public. The average citizen appears to have lost faith in the central banks’ ability to manage the inflation rate over the long term.

It will be interesting to see what happens in a year or two, if central banks will be willing to reduce the monetary stimulus that they’re applying. If the monetary stimulus isn’t reduced, we might be setting up for a much higher inflation rate later this decade than many people expect.