Maybe the enemy wasn't inflation after all, but derivatives.

The nation's central bank has justified its interest rate hikes this year as insurance against the barely visible foe of inflation.

But the real benefit of the Federal Reserve's ever-bolder credit tightening campaign, whether intended or not, may have been in controlling the rise of the volatile financial contracts.

The debacle in Orange County, Calif., which lost more than $2 billion on its derivatives holdings, has prompted some economists to take a second look at the Fed's activities.

Even critics who have questioned the Fed's hunt for inflation are sounding a bit different these days.

"I humbly apologize for being so critical earlier this year. Rates were too low," said Edward Yardeni, chief economist at C.J. Lawrence/Deutsche Bank Securities Corp.

The low rates sparked "an almost hysterical demand for higher returns by investors," he said. Wall Street responded with financial products offering better yields than those in the money markets as long as money market rates remained low.

"If the Fed had kept rates low, derivatives might have been in all our portfolios by now," he said. "The ultimate financial debacle would have been ugly and a big negative for the real economy."

In its wisdom, he said, the Fed may well have averted a repeat of the "financial engineering" upheaval that caused Japan's stock market and real estate market to crash in 1990 and has since held back recovery of that nation's economy.

The central bank began tightening credit last Feb. 4. So far this year, it has raised the federal funds rate by 250 basis points in six installments to a target of 5.5% and the discount rate in three moves by 150 basis points to 4.5%.

"In hindsight, the Fed should have started raising interest rates even sooner. The derivatives-type problems would not have progressed as much as they have," said Sung Won Sohn, chief economist at Norwest Corp., Minneapolis.

If they waited another six months, he said, "I would guess that every Tom, Dick, and Harry this side of the moon would have been in it."

But Mr. Sohn views the derivatives difficulties this year as a learning process with inevitable costs. "It is part of the price we have to pay to understand and utilize derivatives more effectively in the future."

Neither Mr. Yardeni nor Mr. Sohn anticipate a fresh rate increase on Tuesday, when the policymaking Federal Open Market Committee meets in Washington for the last time this year.

"I would be very surprised if they did anything on rates," said Mr. Sohn. "More people are anticipating a slowdown next year, and I imagine the Fed staff is also."

Monetary policy actions are seen as having a lag of six to nine months before filtering into the economy. Any rate action by the Fed now probably would not affect business conditions until the second half of next year, he said.

"That's pretty far away, and by then we might find the Fed has overdone it, as they have in the past" he said. "And then they might have to ease monetary policy, as they did in 1989. The Fed would not like to repeat that."

The key question, he said, is how much of the impact of the previous rates hikes remains yet to be felt in the economy. "It's a judgment call as to how much cold water is in the pipeline at this point," he said.

Mr. Yardeni, who still doubts that inflation will flare up, expects the Fed to tighten further, but not until early next year. Fallout from the Orange County fiasco will probably lead the Fed to put off any action on Tuesday, he thinks.

"I predict the Fed will raise the federal funds rate by another 100 basis points, to 6.5%," he said, probably in two increments early next year.

The first 1995 meeting of the Open Market Committee, a two-day organizational meeting for the year, is set for Jan. 31 and Feb.1. By then, data will be available about the strength of the Christmas shopping season, as well as the latest Fed "Beige Book" on economic conditions, due Jan. 18.

After that, the group is scheduled to meet twice more in the first half of the year, on March 28 and May 23. In the second six months of the year, meetings are set for July 5-6, Aug. 22, Sept. 26, Nov. 15, and Dec. 19.

The monetary committee delegates authority to Fed Chairman Alan Greenspan between meetings, however. Mr. Greenspan can also convene the committee by telephone if he believes events warrant.

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