Forget all the fancy talk about the neutral rate and the output gap. The two fundamental questions facing the Fed are simple to say and complex to answer: Is the world’s most powerful central bank ultimately committed to bringing monetary policy back to the real economy rather than financial markets? Can it proceed in an orderly manner?

These issues have not been fully grasped by the market, and for good reason. From their perspective, the risk of the Fed not following the market is too costly. However, even if they turn out to be correct, markets are likely to find themselves having much less influence on monetary policy than they have recently.

The context of the current situation is well known. For a long time, monetary policy was basically adopted by the market. This phenomenon is naive to begin with, as central banks want to counter the damage to economic well-being caused by market failures. Massive liquidity injections and rock-bottom interest rates have become a habit rather than a targeted implementation that rarely happens.

Time and again, the Fed has felt compelled to use its potent liquidity-creation weapons to counter falling asset prices, even when the risk of market disorder and volatility is not apparent. Sometimes, such “unconventional” measures are aligned with the needs of the real economy. However, many times, they are not.

Just as a child successfully throws a tantrum to get more candy, as long as there is a strong scent of instability, the market expects more accommodative financial conditions. This expectation turned into persistence. The Fed, in turn, has shifted from merely responding to market volatility to trying to preempt it.

Central bankers are not turning a blind eye to unhealthy co-dependence. The current leaders of the Federal Reserve and the European Central Bank, Jay Powell and Christine Lagarde, sought to change that dynamic early in their tenures. But they failed and were forced to make an embarrassing U-turn that gave the market more strength and a right to stick to a continuation of the ultra-easy policy.

Today, however, two decades of market-led monetary policy are being threatened by unprecedentedly high and persistent inflation.

Faced with accelerating price increases that wreak havoc on living standards, erode future growth prospects and hit the most vulnerable segments of society hardest, central banks have little choice but to consider downgrades.

The situation is particularly acute for the Fed, given its gross mischaracterization of inflation for much of last year and its belated failure to act decisively when it realized that price instability had taken root under its watch.

But given how much the Fed’s delayed understanding and response has narrowed the path to orderly deflation, how best to do that is a question. That said, it will only increase the difficulty of reducing inflation without unduly harming economic well-being. To that end, the central bank should have launched a policy pivot a year ago.

If the Fed now confirms market expectations for aggressive rate hikes, starting with a 50 basis point hike when its top policy committee next meets on May 3-4, it could see them pricing in further tightening. The result of this dynamic will be an even bigger policy mistake as the Fed pushes the economy into recession.

However, if the central bank fails to verify market pricing, it could further undermine its policy credibility. This will weaken inflation expectations, leading to inflationary problems that persist into 2023 and beyond.

The situation is further complicated by the fact that both options could lead to a degree of financial instability in the United States and elsewhere. Worse yet – and this is likely the most likely outcome – the Fed could go from tightening to easing and then again over the next 12 to 24 months.

The Fed might describe this flipping behavior as flexible, but it would prolong the stagflation trend, weaken its institutional position, and decisively fail to put monetary policy back in the service of the real economy. For those in the market who see it as a victory, it may be a short-lived victory at best.

The era of monetary policy returning to serve the real economy has come. This is far from an automatic and smooth process at this later stage. However, if this is not done, the problem is much bigger.