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Addicted to Easy Money?

In an interview with CNBC’s Maria Bartiromo yesterday, Richmond Fed president Jeffrey Lacker refused to offer any clear sign as to when the central bank might finally end its zero-bound policy and begin raising rates. When asked whether he was worried about future inflation, Lacker said he thinks “we’re in a good place with inflation right now.” And when asked whether the U.S. would move to lift rates in 2010, he said, “It could take longer than that.”

Look, I would have asked Lacker if the Fed will tighten policy in my lifetime. He wouldn’t even commit to 2010.

Meanwhile, Lacker never once mentioned the dollar, which continues its decline virtually on a daily basis. Nor did he mention record gold prices. Nor did he mention rising commodity prices, including oil. Even the Treasury bond-market TIPS inflation spread has moved from zero to 220 basis points this year.

Lacker instead seems to be focused exclusively on GDP. But GDP is a lagging indicator. Lacker and Fed policymakers should be focusing on forward-looking leading indicators, like inflation-sensitive market prices.

Unfortunately, all of this sounds eerily familiar to the Fed’s big mistake seven years ago — the one that unleashed an inflationary bubble that eventually destroyed the economy.

Here’s something worth considering: What happens if the economy recovers faster and sooner than the Fed thinks? What happens if the unemployment rate comes down faster and sooner than the Fed thinks? If the Fed suddenly turns the spigot off because the economy is more V-shaped — raising rates and withdrawing cash — the stock market may very well get walloped.

Or what if the dollar- and gold-market vigilantes force the Fed to take action? Bernanke & Co. cannot ignore the currency- and gold-market rebellion forever.

What’s the bottom line here? If you use the wrong model of inflation as your guide, you’re going to get the wrong results.

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