April 2 (Bloomberg) -- Federal Reserve Chairman Ben Bernanke's testimony last week before Congress, scolding the market for believing the central bank had dropped its inflation bias, highlighted the tightrope on which the Fed chief is tiptoeing.

With each communication comes the delicate balancing act of not seeming to underestimate the potential economic risks of the current housing market plunge, while also making skeptical investors think the Fed is tough on inflation.

Call it the Bernanke Bind.

The new Fed boss is a strong believer in both inflation targeting as well as the idea that new central bank heads must quickly establish their bona fides as unyielding inflation fighters.

As most of the market understands, the core personal consumption expenditures index -- the inflation measure of choice for the Fed since 2000 -- has been hovering above Bernanke's perceived 1 percent to 2 percent ``comfort zone'' for several months, now at 2.4 percent.

From this singular perspective the Bernanke Fed should take a hawkish stance. How can the chairman convince markets that he is an inflation warrior if he winks month after month at core inflation above the level widely thought to be his target?

Then there is the housing market. While a smooth landing isn't out of the question, the recent fallout from subprime mortgages only reinforces worries that the housing slump might be a worse drag on the economy than the Fed is counting on.

Far From Pretty

The latest numbers are far from pretty. There is a 6.7- month supply of existing unsold homes on the market, a large number of risky adjustable-rate mortgages due to reset, falling new home sales and the possible decline in consumer spending as equity withdrawal contracts.

Given these indicators, the Fed felt compelled to change its language in the March 21 statement from ``tentative signs of stabilization have appeared in the housing market'' to ``adjustment in the housing sector is ongoing.''

Combine housing risks with disappointing February durable goods numbers, a decline in non-residential investment in the fourth quarter of 2006, uninspired fourth-quarter growth of 2.5 percent and there is ample reason to worry about a slowdown in 2007.

What is a new Fed chairman to do? Tighten interest rates now and risk adding fuel to a housing-led slump. Or cut rates and look like you believe core inflation higher than 2 percent is nothing to worry about.

Hit Pause

The Fed's solution to the Bernanke Bind: push the pause button on interest rates and use Federal Open Market Committee statements and Board member speeches to assure the market that you are ready to hit the inflation fighting fast-forward button at any moment.

Walking tightropes is a tough act. Based on the definition of neutrality that Bernanke laid out in his congressional testimony -- an equal likelihood of raising or cutting interest rates -- the market ain't buying his plea that he would rather hike than lower.

Those who bet in the Fed futures market have priced in almost a 100 percent chance of an interest rate cut by September. And while JPMorgan Chase & Co.'s economic team is buying the Fed language -- it is predicting a 50-basis-point increase by the end of 2007 -- they are a distinct minority. Goldman Sachs Group Inc., Merrill Lynch & Co., and Deutsche Bank AG are among the many predicting cuts of at least 50-basis points in 2007 or in early 2008.

The most recent surveys of a wide group of economists by Bloomberg and the Wall Street Journal both show median forecasts of at least one rate cut by December.

Clear Explanations

While the monetary decisions of the Bernanke Fed have been sound, watching the tightrope act offers some lessons in why the chairman's goal to set an official inflation target may not promote the transparency he desires.

Why? Because the pressure to live up to a perceived though unofficial inflation target seems to be hampering the Fed from being clear in explaining its concerns over economic weakness.

Perhaps Fed Governor and inflation-target advocate Frederic Mishkin was seeking to openly address the Fed's bind last month when he seemed to acknowledge that reaching the current target of 1 percent to 2 percent core inflation might be too ``time- consuming'' and painful.

The Fed appears boxed in. It has to talk tougher than the market believes in order to beat back the perception that it's willingness to live with inflation above the unofficial target isn't a sign of dovishness.

If so, this hardly argues that setting an official inflation target will be a win for more Fed transparency.

(Gene Sperling, author of ``The Pro-Growth Progressive,'' is a Bloomberg News columnist. He served as President Bill Clinton's top economic adviser, and he is a senior fellow at the Center for American Progress. The opinions expressed are his own.)

To contact the writer of this column: Gene Sperling in Washington at gsperling@cfr.org.

Last Updated: April 2, 2007 00:10 EDT