Resident Fellow  Desmond Lachman

Sir, Your editorial ("Monetary minefield", July 17) proposes that, if the Federal Reserve were to lose its balance on its monetary policy tightrope, it should choose to fall on the side of controlling inflation, not sustaining economic growth. However, three considerations would argue against your intimation that the Fed's present policy stance might be inappropriately accommodative.

First, while over the past year the Fed has aggressively reduced the federal funds rate to 2 per cent, the credit crisis has resulted in a substantial widening in credit spreads. As a result, the relevant longer-term interest rates at which both households and corporations borrow today are little different from what they were in August 2007 when the Fed's interest-rate-cutting cycle began.

Second, the US monetary and credit aggregates are now decelerating at an alarming rate, suggesting that a further marked economic slowdown lies ahead. In particular, bank credit is now declining at the fastest rate of the past 40 years.

Third, as Ben Bernanke, the Fed chairman, himself acknowledged in his mid-year congressional report, the risks to economic growth are now clearly skewed to the downside as the US economy is being buffeted by a constellation of negative shocks. These shocks include the worst housing market bust since the Great Depression, the most wrenching credit crunch in the postwar period and a run-up in oil prices that now exceeds that of the 1979 oil price shock, even after adjusting for inflation.

With no sign that any of these shocks are attenuating, it is difficult to see how the US can avoid a prolonged recession once the stimulatory effect of the present tax rebate programme abates later in the year. One has to hope that Mr. Bernanke, a renowned expert on the Great Depression and the Japanese experience in the 1990s, does not repeat the mistake of engaging in a premature monetary policy tightening to slay a supposed inflation dragon, which will be more than taken care of by the opening up of large gaps in the US labour and product markets.

Desmond Lachman is a resident fellow at AEI.