Yesterday’s Federal Reserve policy statement not only failed to defend King Dollar, it actually shifted on balance to a more dovish position. The FOMC looks like it’s more worried about the economy than it was a month ago and less worried about inflation in the wake of plunging oil prices.

The drill, drill, drill political scenario coming out of Washington and spreading throughout the country is really helping Fed policy right now. Since President Bush launched his offensive to roll back the drilling moratorium, the oil price has dropped more than $30 from near $150 to below $120. The barrel price is actually down again today to around $118. In connection with the big oil drop, gold has fallen and the dollar has appreciated. Gas prices at the pump have come off about 25 cents. Presumably, headline inflation will moderate a bit next month.

So you might say drill, drill, drill along with reduced energy demands is lending a big helping hand to the Fed’s inflation worry.

At the same time, these energy-price drops are acting much like a tax cut on the economy and the stock market. So it’s understandable that stocks have picked up since mid-July. The likelihood is that the economy at the margin will do better, not worse, in the months ahead. The oil-price shock has really taken a toll on the economy and stocks over the past nine months, and to the extent this shock is reversed, it’s great news.

September 30 is the cutoff for the congressional moratorium on domestic and offshore drilling. Republican Sen. Jim DeMint is mounting a campaign to shut down the government’s budget appropriations unless there is a clear up-and-down vote on the expiring moratorium. The GOP, with the public behind them, knows full well that chances for congressional pickups rather than losses are at stake in this oil battle.

But the Fed should really stick to its own knitting on inflation control. Energy deregulation leading to more supply production is a great pro-growth tonic for the economy. The Fed, however, should be aiming for price stability and King Dollar. There are two policy levers here. One is the tax-cut effect of drill, drill, drill. The other is monetary restraint for the anti-inflation goal of price stability and a strong greenback.

While gold has come down — it is still $882 — the chance that this lofty gold level is consistent with inflation of 2 percent or less is very low. Using a bond-market model of real interest rates and inflation expectations, monetary policy over the past year has become very loose again. The real federal funds target rate has dropped from nearly 3 percent to negative territory. The yield curve differential between 10-year Treasury rates and the fed funds rate was negative from mid-2006 to the end of 2007, indicating tight money. But that yield spread has turned quite positive in 2008.

Meanwhile, the adjusted monetary base controlled by the central bank has shifted from minus-4 percent growth at the beginning of this year to plus-9 percent growth at an annual rate. And while the greenback has stabilized as a result of the oil drop, it hasn’t yet really broken out into a stronger range.

There are basically two key question marks hovering around this potential stock market summer rally: First, will we get an America-first energy policy with total deregulation that would produce more supplies to bring prices even lower and create more jobs for economic recovery in the process? And second, will the Phillips-curve-minded Fed go back to inflation-targeting, price-level stability, and King Dollar?

For Goldilocks to truly succeed, both conditions must be met.