Everyone remotely associated with the market is wondering what's going on inside the cloistered confines of the

Federal Reserve's

Federal Open Market Committee. One market watcher, until very recently a Fed insider, says get ready for substantial moves very soon.

The FOMC announced that it was holding pat on rates while indicating

rate cuts are coming. Moments earlier, Michael J. Prell, the Fed's former director of research and chief domestic economic forecaster, said that even if they don't cut rates today, the next few months will see lower interest rates.

When

last we checked in with Prell in early September, he was worried about the possibility that a rising stock market and higher energy prices might force the Fed to raise interest rates. Today, obviously his thinking has changed a bit in light of the recent signs of economic slowing and the further bursting of the

Nasdaq

stock bubble. What is Prell, who is now an independent economic consultant in Arlington, Va., after leaving the Fed earlier this year, thinking about on FOMC Day? Read on.

First, he said he expected that the FOMC would either cut the

fed funds rate today (which it didn't) or signal that they will be cutting in the months ahead (which it did).

"

Greenspan would not have made the speech on Dec. 5 unless he thought there was a high probability that they would be cutting rates in the next few months," said Prell. He is persuaded that the Fed that emitted signals in recent press stories that there's been a shift within the open market committee toward a "balance-of-risks statement" more concerned about economic weakness. "That said, there is also a non-negligible probability of a neutral balance-of-risks statement, and on the other side, of an actual cut in rates."

How low might rates go in the event of a serious slowing? "If we are really witnessing the bursting of a significant speculative bubble, then there may be potentially a considerable economic downdraft that would require sizable rate cuts, more than is built into the market right now," he said. He added that the credit markets are already forecasting a roughly 1 percentage-point reduction in the funds rate by next fall. "Greenspan has in effect signaled that if this is serious, they would not be dilatory if they see things crumbling in a major way. The rate-cutting process would be more compressed in time if they see something on the order of a recession."

In Prell's view, we are now on the other, less-appealing side of the "speculative mountain that was built on top of a very nice, honest-to-goodness hill made possible by the real productivity improvements." He is "agnostic" on whether the pace of recent structural improvements in productivity is sustainable or not. But he is quite clear that we will continue to see "the reversal of the speculative boom element."

What can the Fed do to limit the extent of an economic downturn?

"If the contraction is the result of a sharp reduction in productive capacity, related to the curtailment of supply of key inputs -- such as oil -- the Fed's ability to moderate the downswing is more circumscribed," he emailed me today. "That isn't the classical business cycle story, and it is only a part of the current episode; indeed, the energy price crunch (which is much more than oil) is to a significant degree attributable to greater-than-anticipated demand growth, against a backdrop of in some cases artificially restricted capacity expansion." Prell also noted that "adding monetary stimulus in such a situation may have disproportionate effects on prices as opposed to output and employment."

And what about if the slowing economy is due more to weakening household consumption and corporate investment?

"If the recessionary downdraft is attributable more to demand weakening, then monetary policy is likely to be a more effective antidote," writes Prell. "The Fed obviously is struggling to gauge just how intense the softening of demand is currently and prospectively, and how financial market stress might affect the potential potency of a given amount of monetary policy easing (i.e., cuts in the federal-funds rate). It is doing so against a backdrop of labor market tightness that is exerting some inflationary pressure -- pressure that it would like to see eliminated."

There you have Prell's pearls of wisdom.