The US Federal Reserve is the only central bank in the world that operates under the express dual mandate of maintaining both price stability and full employment. That can leave the Fed in a pickle from time to time, particularly when deflation threatens the economy.

Here’s the problem with deflation in simple terms. Consumers hold off purchases in anticipation of lower future prices at a time when fiscal and monetary authorities are trying to boost consumption and get the economy back on track. Consumer demand falls as purchases are delayed, compressing margins at businesses and discouraging hiring.

In this situation, a dose of inflation can be just what the doctor ordered. Inflation encourages investors to make purchases, because they anticipate that higher prices are around the corner.

Generally speaking, the Fed relies on tweaking interest rates to control inflation. Setting the short-term federal funds rates below expected inflation rates reduces credit costs and spurs borrowing for investment, thus boosting inflation. Setting interest rates above anticipated inflation rates has the opposite effect.

Historically, the federal funds rate has been the Fed’s primary tool to control inflation expectations and encourage or discourage consumption.

But with the target rate pushing the zero bound for almost two years, such an approach is no longer an option. At this point, monetary policy is almost the only arrow left in the Fed’s quiver, making another round of quantitative easing (QE) a near certainty.

Quantitative easing is known colloquially as “printing money,” though today it’s achieved with a computer rather than a printing press. The Federal Reserve grows its balance sheet by purchasing long-term assets such as Treasuries from money-center banks and other debt-holders, putting more dollars into circulation. Fiscal authorities hope that by adding cash to banks’ balance sheets in a low-rate environment, more loans will be made to encourage current investment and consumption.

The problem with another round of QE is that it’s predicated on the belief that banks are reluctant to lend or that they need more resources to meet demand. I don’t believe that’s the case and neither do many other market participants.

According to the Federal Reserve’s latest Senior Loan Officer Opinion Survey on Bank Lending Practices, lending standards have eased on commercial and industrial loans to firms of all sizes, as that market has become more competitive amid a sluggish economic recovery.

The survey also reported that larger banks are easing standards on residential lending. That suggests that banks are able and willing to make loans but demand for those loans hasn’t materialized. If that’s the case, another round of QE is likely to create more damaging inflation than an uptick in consumption.

There’s a fine distinction between positive and damaging inflation.

Positive inflation occurs when both prices and incomes rise in tandem, allowing purchasing power to offset rising prices. Damaging inflation occurs when a devalued dollar results in higher input costs–most commodities are priced in dollars–and increases the cost of finished goods, even though consumers can’t pay higher prices.

The danger is that with widespread unemployment workers won’t be able to push for higher wages while prices are rising. Meanwhile, companies might not be able to pass along cost increases to consumers, thereby squeezing margins and discouraging hiring. It’s possible that the Fed’s effort to stoke inflation could take, but that the move won’t spur hiring.

The Federal Reserve’s dual mandate means that the central bank will have to walk a tightrope without a safety net. That’s one of the reasons we’ve seen a run-up in commodities prices. At this point a commodities bubble is unlikely, but prices could still hit 2008 levels as investors take shelter in oil and other resources

In regards to commodities, I side with the British scholar Thomas Robert Malthus. Commodities are finite resources under pressure from population growth; commodity exposure is a pillar to a well-constructed portfolio. Although commodity prices have had their run and bubbles may be forming, most prices have yet to reach pre-recession levels, to say nothing of their 2008 highs.

Investors who are underweight commodities should bulk up now. While there’s little chance we’ll enter a hyperinflationary environment, the Fed’s efforts to boost inflation should result in a bull market for commodities.

Hot Commodity

Fidelity Select Materials Portfolio (FSDPX) focuses on companies that produce, process or distribute raw materials. The bulk of the fund’s top 10 holdings are in the specialty chemicals segment, which is predominantly driven by petroleum. With more than 50 percent of the fund’s assets allocated to its top 10 holdings, oil will largely drive the fund’s performance.

But this Fidelity offering also has significant exposure to agricultural commodities through holdings such as Monsanto (NYSE: MON). Stakes in Freeport-McMoRan Copper & Gold (NYSE: FCX) and Newmont Mining Corp (NYSE: NEM), among others, provide ample exposure to gold and a host of industrial metals.

Manager Tobias Welo is mindful of valuations and sticks with companies that are competitively positioned within their industries. Over the past several months he’s positioned the portfolio to take advantage of an inflationary environment, making larger allocations to foreign markets and metals, both of which should benefit from a depreciating dollar.

While Fidelity Select Materials’ 0.94 percent expense ratio is a bit more expensive than what you’d find in other natural-resources funds, it’s well below the 1.54 percent category average. That makes it a sensible long-term holding, both as a hedge against Federal Reserve missteps and as a means to benefit from rising commodity prices.