Testifying on Capitol Hill on Feb. 27, Federal Reserve Chairman Ben Ber-nanke explained the central bank's policy dilemma. On one hand, he said, "financial markets continue to be under considerable stress," and the risks to the economic outlook "remain to the downside." The right treatment for those problems is lower interest rates. On the other hand, he said, inflation has risen. The orthodox remedy for that is higher rates. One day before his semiannual testimony, the government said producer prices soared in January, bringing the annualized increase over the past three months to nearly 11%.
So far Bernanke and his colleagues have chosen the side of cutting rates, betting, he said on Feb. 27, that inflation will "moderate significantly." But if higher inflation sticks, the Fed's policy dilemma will sharpen.