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Bernanke's Big Bet


The Federal Reserve's latest move has investors focused on the slowing economy, but the central bank is taking a big risk if it falls behind in the battle against inflation, economists said.

The Fed held interest rates steady for the first time in two years Tuesday, in effect making a big bet that, for now, slowing economic growth will take the edge off rises in inflation moving forward...

The Fed raises rates when it wants to slow the economy and ward off inflation; it cuts them to spur growth.

Right now, the central bank is trying to engineer a so-called soft landing, slowing growth and keeping inflation in check without sparking a recession. But that's a tough task. The Fed did it under former chairman Alan Greenspan in the mid-1990s but couldn't in 2000, and a recession followed.

Economic readings on inflation may be backward looking, but even leading indicators show inflation remains elevated, according to Lakshman Achuthan, managing director of The Economic Cycle Research Institute, an independent group dedicated to economic cycle research...

The institute's Future Inflation Gauge, which is closely watched by financial markets and was a favorite of Greenspan's, shows indicators peaked in late 2005, which suggests actual inflation will hit its highest point this fall, Achuthan said.

"But it's premature to say we've whipped inflation," he said, noting there has yet to be a sharp downturn in the leading indicators. "We must remain guarded about being too optimistic. It's premature to say inflation's a non-issue."

The Fed said in its statement that "some inflation risks remain" and left itself room to raise rates again in September. But even by then, the Fed may still be waiting for signs that its rate hike are impacting inflation...
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