Between a rock and a hard place

That's where the Fed finds itself currently, trying to balance its dual mandate of price stability and full employment.

As Randall Forsyth writes in this week's Barron's (subscription required):

Friday's jobs data underscored Wednesday's reiteration by the Federal Reserve that it will keep its key policy rate at 0-0.25% "for an extended period." What was new was that monetary authorities also outlined the conditions that would justify keeping rates at rock bottom: "low rates of resource utilization, subdued inflation trends, and stable inflation expectations." Translated from Fedspeak, "resource utilization" is unemployment; it is now paramount to Bernanke & Co. that the official jobless rate is over the psychologically important 10%.

But the second and third conditions pose a dilemma for policy makers, says Mohamed El-Erian, Pimco's chief executive and co-chief investment officer. While the jobless rate argues for continued low rates, the other two conditions - inflation trends and inflation expectation - are flashing yellow lights. Gold touched $1,100 an ounce last week while the Treasury Inflation Protected Securities market was indicating higher inflation expectations. Then, he adds, there's the question of the Fed's policies feeding asset bubbles, a lesson we should have learned from the past.

"Putting it together, there's no right answer" as to whether the Fed should raise rates or wait, El-Erian says in an interview at Pimco's Newport Beach office. "It's a question of which mistake you're willing to make," which is why he says he doesn't envy policymakers these days.

I don't envy them either. This dilemma helps explain why we've become so nervous about inflation this year. It's a classic "pick your poison" scenario: raise rates to fight emerging inflation and be rewarded with more economic pain plus prolonged/higher unemployment. Or leave them low and risk letting the inflation genie out of the bottle.
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Mark Biller is Sound Mind Investing's Executive Editor. Visit www.soundmindinvesting.com to learn more.