No matter how dire your outlook for the real economy may be, the first question that must be asked is, How much benefit could another 1/4-point cut provide? For home purchases, for example, the expected change in house prices and income over the next 12 months is likely to be a more important factor than the interest rate in the current environment. And even if the interest rate were the most important variable, it’s not clear how much a 1/4-point reduction in the fed funds rate would actually matter for the cost of borrowing. For example, over the last six months, the Fed has cut the target by 250 basis points, while the cost of a 30-year jumbo mortgage rose 60 basis points. That’s if you can still get the jumbo loan, which you may well not.

By contrast, there is a compelling case that by rapidly bringing the yield on short-term Treasury bills well below the prevailing inflation rate, the Fed has played a role in the significant depreciation of the dollar and increase in the dollar price of virtually every storable commodity that we’ve seen since the beginning of January. A USA Today/Gallup survey this week found that 80% of Americans are worried about rising gasoline prices and 73% about rising food prices, with about half of respondents claiming that these price increases had created hardships for them. Would lurching further down that road really stimulate consumer spending?

Markets are assuming that Bernanke will go to 2.0, and that expectation is built into the current price of storable commodities and the dollar. If the Fed instead surprises the market with a little restraint next week, I predict that we’d see immediate adjustments in those prices.

In part those effects would result from changing the fundamentals, surprising speculators with a higher real interest rate and firmer inflation-fighting commitment from the Fed than the market is currently assuming. But it’s possible in my mind that there also is a psychological component to the current commodity speculation as well, in which case the Fed has a rare opportunity right now to get some extra benefits on the inflation front by breaking that psychology. However, if the Fed waits and lets the present perceptions become more entrenched, that same psychology could turn out to be a factor that later proves to work against the Fed and make anything it tries to do more difficult.

The Fed’s credibility as an institution that will not tolerate a resurgence of inflation is absolutely critical for its ability to achieve its dual mandate. If the Fed loses that credibility, monetary expansion brings inflation but little output improvement, and monetary contraction brings a recession but little relief on inflation. When consumers report in the latest Michigan/Reuters survey that they expect 4.8% inflation over the next year, the Fed has a real problem in that department. If the Fed waits to pause until the June 24/25 meeting, it may find itself swimming against that credibility current for many years to come. I believe that the Fed has a unique opportunity to signal its true commitment at next week’s meeting that may not come again any time soon.

Furthermore, if I am reading this correctly, we will not have to wait around to ponder what the outcome means. If the Fed surprises the market with a pause, we should have unambiguous confirmation or refutation of the hypothesis that the Fed has been contributing to the commodity price run-up within 48 hours of the FOMC’s announcement. That knowledge in itself would also be extremely valuable– valuable to the Fed in calculating how to chart its course from here, and valuable in terms of making clear to the public why sometimes higher interest rates are the better choice for public policy.