William Poole (president of the St. Lous Fed) made some very direct comments during a recent speech:

In this environment, Poole said there were two cases where it would be "pretty clear" how the Fed will respond.

He said if economic indicators show output and inflation are rising above Fed forecasts, the Fed will hike rates. If output and inflation are weaker than expected, the Fed will, at some point, ease.

The difficult case will come if the outlook for inflation and output move in opposite directions, he said. In these circumstances, Poole said he would be guided by a strong commitment to keep inflation low and stable.

"Accepting higher inflation, or even a continuation of the current rate of inflation, in an effort to sustain current employment levels will only lead to more grief later," Poole said.

Essentially, Poole is saying that the Fed is willing to do a "Volcker redux": high interest rates as a medicine to cure inflation, even if stagnation is going on at the same time. This is key because, I think, this is actually the kind of economy we are headed into, and already beginning to experience, as the latest core inflation news reinforces:

The core personal consumption expenditure price index -- the key inflation gauge followed by the Federal Reserve -- has gained 2.5% in the past 12 months, the most since January 1995.

The real question is whether high interest rates will actually do anything to quell inflation; based on the always-on Fed creation of credit, it seems more like the only function of interest rate increases during stagflation would be to stave off a total international loss in confidence in the dollar.