Fed Actions Stir Early Concerns of Inflation

The Federal Reserve's aggressive action on Wednesday to buy up Treasury bonds and mortgage-backed securities is designed to jolt the economy out of its doldrums, but at a potentially high price - the risk of triggering rapid inflation.

If that happens, the current low interest rates could quickly become a thing of the past as the Fed changes course to squeeze inflation out of the economy, as it did in the 1980s.

Wall Street's initial reaction to the Wednesday's move was positive, as stocks surged following the unexpected news that the Fed would buy back up to $300 billion in long-term treasury notes and another $700 billion in mortgage securities. Both measures are intended to lower interest rates and free up credit. But stocks fell back again on Thursday and gold futures - considered a key bellwether of inflation concerns - rose sharply on the day, finishing up 8 percent at over $960 an ounce.

The Fed's actions are basically pumping money into the economy, which usually is considered inflationary, since you have a bigger pool of money available to purchase a limited amount of goods and services - so prices rise. But in the current economy, one of the biggest fears has been deflation - a destructive drop in prices that feeds on itself and brings on a depression - so many economists have regarded a little inflationary stimulus at this point as possibly a good thing.

However, there are certain signs in the economy that indicate that the likelihood of deflation and a depression may be waning - the consumer price index rose 0.4 percent in Februray, following a 0.3 percent gain the month before and stands at a 1.8 percent rate for the previous year - generally considered an acceptable figure. Combined with Thursday's jump in gold futures and other commodities - which, being tangible assets are considered hedges against inflation - and you have an indication that at least some investors are concerned the Fed's actions will be inflationary in the long run.

Economists appear to be divided on the issue. Some say the economy remains so weak that it's unlikely prices will begin to rise sharply anytime soon, allowing the Fed time to throttle things back before inflation gets out of control. Others contend that the sheer volume of debt the government is incurring is essentially unmanageable, and inflation will explode as a huge pool of diluted dollars chases after a reduced stockpile of consumer goods and a diminished commercial sector is unable to keep up with demand.

If that happens, one remedy is for the Fed to raise interest rates in an effort to damp down the inflationary fires, as it did in the early 1980s. Those measures were successful, but they also triggered a serious recession. But given the current economic situation, the Fed may find that a very unappealing option.