Fighting inflation versus short-term rate cuts

Covered in today's L.A. Land blog is the latest from columnist Lou Barnes, in which he argues that countering inflation should be the Federal Reserve's first priority even though voters will clamor for more short-term rate cuts:

Today Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson will meet with President Bush at the White House. Oh, to be a fly on the oval wall. Will the visitors tell Dad what happened to the family car, or will equivocation and procrastination prevail? This administration leans to market solutions or tax cuts. Fiscal stimulus might be in order, following Larry Summers' "Three T's" rule: timely, targeted and temporary. Quickly cutting FICA taxes to zero below a certain income limit is a reasonable, never-tried idea, but Bush and this Congress will never get a tax cut done in time, or properly.

The only other nonbailout rescue is monetary policy. Translation: BIG cuts in the 4.25 percent overnight cost of money, and going inter-meeting -- the Jan. 30 and March 18 schedule is a long time to wait.

Here is the compound and circular problem with that rescue: The bond market won't like the inflationary consequences. The economy and especially housing need lower long-term rates; if the Fed appears to abandon discipline, long rates will rise no matter how far the Fed cuts. As morning trading wears on today, that very thing is happening: Bonds are losing early gains...

And, since long-term (i.e., mortgage) rates are determined more by the risk of future inflation than short-term borrowing costs:

The appropriate Fed policy cannot be discussed in public. No Fed chair can tell the American people: "We will be slow to ease on purpose, following the economy downhill, making no effort to preempt recession until inflation is clearly under control." A Fed chair can embark on a public fight against inflation only when the public feels its pain; Bernanke must engage in brinkmanship to hold inflation below the 2 percent bound -- a priority on nobody's screen except bond investors.

It's the only way to get long-term rates down, and to achieve a durable rescue.

The nice thing about Lou Barnes: he pulls no punches.