A journey into Bernanke's thinking

First, a disclaimer: I confess to total ignorance when it comes to Mr. Bernanke's thinking; what follows is pure speculation. Now that's out of the way, let me give it a try. Here goes:

The way I understand it, the most important thing for Bernanke is not inflation but the health of the economy. Put another way, fighting inflation is the Fed's number one priority, as long as the economy is healthy. The key to a healthy economy is, has been for many years and will continue to be the consumer and more precisely the consumer's sense of his or her personal wealth. That particular sense has been somewhat damaged by the fact that house prices stopped going up then started coming down in what appears to be a slow motion train wreck type of action. Now, if the stock market also crashes durably, then the consumer will very likely cut down on consumption and tank the economy. That could happen even if the stock market does not go down and stay down. But it is sure to happen if we enter a prolonged bear market. Most people have a large percentage of their wealth locked in their home and a large percentage of their savings and pension plans in stocks. It figures that if both house values and the stock market go down in unison, consumption will have to take a backseat.

Therefore, one thing Bernanke cannot let happen at this point would be a severe and durable stock market dislocation. He will use "all the tools at his disposal" to prevent just such an event.
Any notion that the Fed is not watching the stock market these days would seem to be very naive. I believe they are watching very closely and are ready to intervene, as they have on August 17th. (By the way, I also happen to believe they leaked their coming rate cut at around noon and major support the day before August 16th, which brought the market back from the brink of disaster, but then again I also tend to believe most conspiracy theories.)

However, preventing a market crash is not the same thing as engineering a rally. The market could stay within a large range where we don't make new lows because of the Fed's actions (or perceived actions) but we don't make new highs because every time we're about to, people come to their senses and send the market back down.

Just my take on things.