June 18 (Bloomberg) -- The Federal Reserve, when considering how much to raise interest rates to keep inflation in check, might call upon the law of gravity: nothing, even the price of oil, goes up forever.

When the cost of a barrel of crude oil touched $140 on June 16, almost double its price a year earlier, the sky may have seemed the limit.

But even with soaring rising demand in China, India and some other emerging-market countries, prices at some point must plateau, and perhaps come down. A doubling of oil prices simply has to reduce demand, which in turn will moderate the price.

So Fed officials have common sense on their side in assuming consumer prices won't increase indefinitely at a 4 percent rate, or higher, because of oil. Food prices are also playing a big role in keeping inflation high at the moment, and they too will eventually top out.

Still, Fed Chairman Ben S. Bernanke and his colleagues want to make sure food and energy inflation doesn't infect the whole U.S. price-setting process. That's why many of them are talking a tough anti-inflation game these days.

``The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations,'' Bernanke told a Boston Federal Reserve Bank conference on June 9. Any public anticipation of accelerating price gains ``would be destabilizing for growth,'' he said.

Complicated Decision

Such warnings have caused many investors to anticipate several quarter-percentage-point increases in the Fed's target rate for overnight loans -- now 2 percent -- later this year, according to federal funds futures contracts. (Only a few investors expect any change at the June 24-25 meeting, though.)

Choosing the best policy course is complicated right now.

While the economy isn't in a recession, the depressed housing sector is holding back growth and the number of payroll jobs is declining. So it's not as if the Fed needs to raise rates to cool off an overheated economy; far from it. Nor would food and energy prices be affected very much by higher interest rates.

The primary purpose of a rate increase now would be to reassure the public that the Fed will do whatever is needed to hold down core inflation, which excludes food and energy prices. If that works -- if the public's expectations for inflation remain low -- then temporarily higher food and energy prices are unlikely to generate higher sustained inflation.

Little Spillover

Fed Vice Chairman Donald L. Kohntold the Boston Fed conference that inflation in the U.S. is driven by three forces - - price shocks, such as those now affecting food and energy costs; inflation expectations; and the balance between aggregate supply and demand.

So far the price shocks aren't spilling over into the core portion of the consumer price index in any substantial way -- or causing wage gains to get bigger. Airline fares, up 14.4 percent in May from a year ago, are an exception, though public transportation as a whole accounts for just more than 1 percent of the entire index.

Meanwhile, average hourly earnings for private sector workers were up only 3.5 percent in the 12 months ended in May, a half percentage point less than in the prior year. According to the Labor Department's employment cost index, which includes wages, salaries and benefit costs, compensation for private industry workers increased 3.2 percent in the 12-month periods ended in both March 2007 and March 2008.

No Sea Change

The slowdown in growth -- the gross domestic product increased at less than a 1 percent annual rate in the fourth quarter of 2007 and the first three months of this year -- makes it unlikely that labor costs are going to add to inflationary pressures anytime soon.

Some private economists have argued that the oil price increases of the past four years, and the more recent food price increases, indicate a sea change in U.S. inflation. There's little evidence to back that up.

In past decades, when inflation exceeded core inflation -- a phenomenon that can be caused by sharp increases in energy prices -- core inflation turned out to be a better predictor of what was to come. In other words, the broader inflation measure always moved back down toward core inflation, rather than vice versa.

At the June 9 conference, Fed President Eric Rosengrensaid new research by his bank's economists suggests that, so far, core inflation is still the better predictor.

Inflation isn't out of control in the U.S. Fed officials are determined to make sure that remains the case, even as they pursue their dual mandate to achieve both stable prices and maximum sustainable employment.

When, as now, inflation and unemployment are both higher than Fed officials and the public would like, policy can't focus on one goal to the exclusion of the other.

Since last summer, officials have had to concentrate on keeping the economy afloat in the face of serious financial market turmoil. The danger of a deep recession has subsided.

So now it's time for some anti-inflation insurance -- in small, moderate doses.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: June 18, 2008 00:04 EDT