Monetary policy: Between a rock and a hard place

Blog note: sorry for being off the radar for a few days - the next few weeks are crunch time for my Master's dissertation. Fortunately, I see my illustrious coauthor has kept you entertained with stories about kites, voicemail, and Schlitz. I'll do my absolute best to keep posting at least once a day.

Anyways, right now is a good time to thank your lucky stars that your name isn't Ben Bernanke and that your business cards don't read "Chairman of the Federal Reserve." Mr. Bernanke is facing a daunting combination of high inflation (year-to-year inflation in June was 4.1%, the largest annual increase since May 1991), anemic growth (1.9% in the 2Q, largely on the back of fiscal stimulus checks), and stubbornly high food and energy prices.

Going into the Fed's August meeting on Tuesday, it's an impossible position to be in. Raise interest rates and you risk aggravating a delicate situation where credit remains tight, energy prices remain volatile, and the housing market may not have quite bottomed out yet. Lower interest rates and you risk stoking the fires of inflation.

What to do? Realistically, probably nothing. In June, the last time the Fed met, they left interest rates unchanged at 2%. Wall Street is betting that they'll do the same thing this time, and I think they've got it right. When interest rates are this low, realistically it's hard to lower them much further, and Mr. Bernanke is still more concerned about pumping liquidity into the system than inflation. The real question becomes: how much inflation is Mr. Bernanke willing to tolerate? If he wants to keep rates this low, it will have to be a lot.