Dollar Sense

A welcome shift to inflation-fighting at the Fed

BY LAW, the Federal Reserve System has a dual mandate: to foster maximum sustainable employment and to fight inflation. For the past several months, Chairman Ben S. Bernanke has been working overtime on the first of those objectives. By swiftly slicing interest rates and offering cheap Fed credit to Wall Street investment banks for the first time in history, Mr. Bernanke has tried to prevent a financial crunch triggered by the subprime mortgage crisis from turning into a second Great Depression.

For the time being, at least, it appears he has succeeded. Though much more sluggish than it was six months ago, the U.S economy has not recorded a quarter of negative growth since the credit crunch began in August. More and more investors and economists are entertaining the hope that Mr. Bernanke's liquidity bath has worked and will stave off disaster long enough for the economy to work through the bad debts piled up during the housing boom.

If so, Mr. Bernanke will have done so at the cost of higher inflation, which reached an annual rate of 3.9 percent in April, well above the Fed's comfort zone. To be sure, a cheaper dollar, a direct result of Mr. Bernanke's interest rate cuts, has stimulated U.S. exports and reduced the costs of repaying foreign creditors. But in a pair of speeches this week, Mr. Bernanke implied that the cheap dollar now risks rekindling inflationary expectations -- which he called a "significant concern." Inflation has probably already thwarted the $168 billion economic stimulus package, much of which will now be dissipated on imported fuel. And that is only the beginning of the havoc that price increases could wreak if they truly get out of control.

In shifting his emphasis to inflation, Mr. Bernanke tacitly recognized the wisdom of critics, including some members of the Fed's own Board of Governors, who have chided him for accepting too much inflationary risk to bail out housing. Whoever was right in that argument, and we tend to think the critics had a point, it's good news that Mr. Bernanke says that he is now on the case. His public words strongly suggested that the Fed will leave interest rates where they are for the time being. And, unusually for a Fed chief, he expressed his support for "a strong and stable" dollar.

Whether he can strike the right balance between the Fed's twin goals remains very much to be seen. To an extent not seen since the 1970s, the Fed faces an acute tradeoff between jobs and prices. An example: Mr. Bernanke supports congressional legislation to slow mortgage foreclosures, but to the extent that it succeeds, it will raise home prices -- thus contributing to inflation. The economy may indeed be headed for a soft landing, as Mr. Bernanke still predicts. But there could be a bumpy ride until we get there.