NO ONE CAN

accuse Ben Bernanke and the Fed's Open Market Committee of not keeping busy. Since last August, when short-term interest rates stood at 5.25%, the Fed has cut rates seven times, often in hefty increments.

On Jan. 21, when markets were closed for Martin Luther King Day, Bernanke called an unscheduled meeting of the FOMC, which cut interest rates by three-quarters of a percentage point the biggest such cut in 25 years. A week later, at its scheduled meeting, the Fed, which has been under intense pressure from Wall Street, lopped off another half point, bringing the overnight bank-lending rate (the so-called federal-funds rate) to 3%.

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And in April the FOMC slashed rates to 2.0%. Bernanke has been trying to stimulate the economy and prevent the mortgage collapse from triggering a recession. So far it does not seem to be working.

Most economists, like most Americans, have cheered the rate cuts as medicine that hopefully will work and in any case will not do much harm. But interest-rate cuts also have a dark side.

It's generally assumed that all things being equal, lower short-term interest rates are better. But this view is simplistic and arguably wrong. Lower rates are a help to people with credit card and margin debt, to be sure. And thanks to Bernanke & Co., many people facing resets on adjustable-rate mortgages will see less severe rate hikes. But for society lower rates are not an unmitigated blessing. People with money in the bank or investments in Treasury bills and other short-term securities will see their income reduced. Retirees and others on fixed incomes, such as pensions, will lose out.

The way to generalize from these examples is to say that lower rates are a boon to borrowers but an affliction to lenders. When people "lend" money, what they are really doing is investing it. The lower rates go, the more we discourage folks from investing and saving dollars, and the more we reward them for borrowing, i.e., for living beyond their means.

When Americans are discouraged from saving, they have only two alternatives. The first is to start spending. This is why lower rates lead to higher prices. You can think of each rate cut as sending a palpable signal to every American: Live better! Spend more! Buy the extra sofa! More videogames! So what if you max out your credit cards and your home-equity line as well? Given that whole forests have been cut down for the books and articles documenting that America consumes too much and saves too little, you can see the problem.

The other option is for people to convert their dollars to another currency. When the Fed cuts rates, it is also saying, "Dollars are a poor investment; try euros or yen or the Brazilian real instead."

This is why the dollar has plunged to an all-time low against the euro and to its lowest level in years against the yen. Furthermore, commodity producers around the world are boosting prices to compensate for what they perceive to be the dollar's shrinking value. Gold has hit $1,000 an ounce; oil has topped $100 a barrel. Even coal and wheat are both way up.

Will this translate to higher consumer prices? It already has. Inflation over the past 12 months has been clocked at a rather alarming 4.3%. After a period last summer in which the Fed emphasized the conflicting pressures of a slowing economy and a weakening dollar, Bernanke and his allies on the FOMC seem strangely cavalier about the latter risk.

Certainly, the economy is facing a slowdown and quite likely a recession. It may already be in one. But it is not clear that cutting rates will cure the problem. Consumers paid too much for homes, and banks lent too much on dubious mortgages. Now the speculative excesses must be undone. Home prices must fall; banks must write off impaired assets. Sooner or later home prices will reach reasonable levels, and banks (or those who have cleaned up their balance sheets) will again find it prudent to lend. Then economic activity will revive, and the cycle will start anew.

But if carried to excess, the Fed's interest-rate medicine could inspire the fear of inflation and delay the onset of recovery. When investors fear inflation, they are reluctant to lend long term, driving bond rates higher. This is why long-term interest rates, including those on fixed mortgages, have stayed fast despite the Fed's best efforts to lower them. A bear market in bonds is a real possibility.

It may seem incongruous for inflation to truly ignite at a time when business activity is cooling. But it happened before, in the 1970s a dreaded era of "stagflation" (stagnant growth combined with high inflation).

If people lose confidence in the Fed's ability, or in its will to keep the dollar strong, businesses will raise the prices of goods and services, and workers will demand wage increases regardless of economic demand just to keep pace with everyone else. In the late '70s galloping inflation so devastated people's faith that Paul Volcker, then Fed chief, had to hike rates to 21.5% to restore credibility. Volcker's rate hikes put the country through a pair of brutal recessions, but to his credit, they succeeded in breaking the inflationary cycle and in reestablishing faith in the dollar's value. Faith is the Fed's true currency. Bernanke would be ill-advised to squander it.