We are flying by the seats of our pants. The Federal Reserve has resorted to an old-fashioned squeeze to exorcise inflation. The question is whether it can be done effectively or whether we are slipping into a future of stop-go policies during which the umemployment and inflation rates periodically flutter past each other, while both remain at historically high levels.

At best, that may be the outlook for next year. Some relatively optimistic economists think that the inflation rate -- now fluctuating between 12 and 14 percent -- might decline to 6 to 7 percent by the end of the 1980. Meanwhile, the unemployment rate, now 5.8 percent, could sail towards 8 percent.

All the political rhetoric not-withstanding, the government has effectively abandoned its effort to achieve the utopian vision of full employment and price stability. Mostly, it's muddling along, struggling to find a combination of inflation and umemployment that is tolerate to most people.

The latest thunderclap from the Federal Reserve only confirms the emergence of monetary policy -- that is, the government's regulation of the money supply and interest rates -- as the chief tool in this graceless balancing act. This reflects political expediency and, compared with the 1960s, the greater emphasis on fighting inflation.

Politicians prefer to cut taxes and increase spending rather than the reverse, which would be the logical anti-inflationary policy. Even if they were so inclined, the budget process is mechanically cumbersome and time consuming.

By contrast, the administratively "independent" Federal Reserve can act quickly on its own. And then members of Congress can enjoy the political luxury of lambasting the Fed no matter what it does.

On one level, the Fed's latest moves constitute a traditional attack on what it regards as excessive lending. By making less money available to banks, the Fed hopes to slow down their lending and, thereby, take pressure off prices. Consequently, the Fed raised to 12 percent its discount rate -- the rate at which commercial banks can borrow from the Fed itself -- and, more important, imposed a new 8 percent reserve requirement on many of the banks' large sources of funds, such as certificates of deposits of $100,000 or more. This means that banks must put aside 8 percent of any additional funds from these sources.

Together, these actions raise bank costs and make it more difficult for banks to compete for new deposits, thus reducing the funds on hand for loans and forcing up lending rates. Already, the prime rate which banks offer to their best corporate customers, has jumped to a record 14.5 percent.

But the process isn't confined to bank lending. Housing, for example, is likely to be hard hit, not because the Fed has directly raised mortgage rates, but because its policies have that effect. Consider the chain reaction.

To relieve their own cash squeeze, commercial banks are likely to sell some of the U.S. government securities -- bonds, notes -- that they hold. This drives prices down and interest rates up: a $10,000 bond with an interest rate of 9 percent will pay an effective rate of 10 percent if the price drops to $9,000.

At this point, depositors at savings associations -- the largest mortgage lenders -- will be able to withdraw their funds and buy these higher-yielding securities. The savings associations will either have less money to lend or will have to pay higher rates to depositors and, then, raise their own mortgage rates. By raising monthly mortgage payments, those higher rates in turn may deter families from borrowing.

The mechanics of this squeeze are relatively straightforward, but, at a second level, the Fed has promised to alter the way it regulates the flow of money into the economy -- a change that, potentially, would rank among the major shifts in economic policy since the end of World War II.

If you regard inflation simply as too much money chasing too few goods, the cure is simple enough: make sure that you don't create too much money. To its critics, the Fed has been doing precisely that for years.

The basic process for affecting the money supply is simple and won't change. By buying U.S. government securities from banks, the Fed supplies them with new money. By selling securities, it withdraws money. Depending on the magnitude and direction of these so-called open market operations, the Fed can undo all its other policies.

In the past, the Fed has conducted these operations by using the federal funds rate -- the interest rate at which banks lend to each other -- as a target. When the funds rate dropped below the target, the Fed sold securities and mopped up money; when the rate exceeded the target, the Fed bought securities and added money.

Disaster, said the critics. Watching interest rates led the Fed to supply too much money, leading to inflation. Now the Fed says it won't use the federal funds rate as a target, but will attempt to control the money supply directly by regulating the amount of new funds to supplied banks.

All this raises as many questions as it answers. A slumping economy may temporarily reduce inflationary pressures, but it also stunts new sources of supply. Take housing. If we discourage contruction today, we may simply create more frustrated demand and more inflationary pressures tomorrow. The same problem applies to basic investment.

No one knows how restrictively the Fed will manage the money supply, but its worth noting that reduced money supply growth doesn't translate immediately into lower wage and price increases. It depends how workers and firms respond -- a subject of violent dispute among economists.

One school believes that today's wage increases primarily reflect yesterday's inflation, which means that any stringent effort to reduce the money supply will mean a severe and protracted slump. Another school argues that once it's clear that money availability won't be relaxed, workers will accept lower wage increases, and firms -- struggling to conserve limited cash -- will demand them. Even then, the transition period to low inflation would involve three to five years of slow growth.