As the US Federal Reserve’s Open Market Committee meets on Tuesday, Ben Bernanke, the chairman, and his colleagues face a difficult challenge. Inflation, as the chairman said recently, remains “uncomfortably high” at the same time that the real economy may be slowing significantly. What is a central banker to do? Raise interest rates further to ensure inflation comes down; lower interest rates to head off the chance of a recession; or do neither, hoping that everything will work itself out? While it is a close call, in the end I believe that somewhat tighter policy is warranted.

As the Fed is relying on economic slack to bring inflation down, the rate decision requires an estimate of the degree of slack going forward. Unfortunately, economic slack – really the gap between current and potential output – is hard to measure. Not only are estimates of the current level of gross domestic product revised for years after the fact, but the growth rate of potential output – that is, growth in the economy’s capacity when resources are used at normal rates – tends to shift without warning.