We never get to be inside the room when the Fed’s Open Market Committee is meeting to decide monetary policy. But we have a pretty good idea that the current two day meeting, which ends tomorrow, is a struggle. Congress gave the Federal Reserve two goals, encourage full employment and maintain price stability. This has historically meant unemployment below 5% and inflation about 2.5%. The Fed’s primary tool, interest rates, is not all that difficult to operate. When the economy is growing too fast, the high demand increase inflation, so you raise interest rates to slow demand. When unemployment rises, its generally because the economy (and prices) is stagnant or contracting, so you lower interest rates to stimulate growth.

But what do you do when prices are rising and the economy is stagnant?

That’s the dilemma and it is the situation the Fed faces today. The problem for the policy makers is that the inflationary prices today are the result of higher energy prices and those prices are the result mostly of speculation, not increased demand. The economy is already sluggish, and energy demand is falling. But prices keep rising. Having the Fed slam on the interest rate brakes may do little for energy prices and a lot of damage to the overall economy.

Most Fed watchers expect the FOMC to leave rates unchanged at this meeting. But everyone is on edge, waiting to see what the Fed says in the statement on economic conditions, which it should release about 2:15pm tomorrow.