NEW YORK (CNN/MONEY) - Stocks sold off across the board on Monday, undermined by investors' fears of higher inflation and rising interest rates. In large part, those fears were a response to Federal Reserve chairman Alan Greenspan's comments last week that the Fed is "prepared to do what is required." That's a euphemism for raising interest rates to restrain inflation.

Given the market's weakness over the past few months, it's obvious that investors feel daunted, especially whenever the Fed appears ready to raise rates.

But to appreciate what's going on, you need to remember that Greenspan's Fed responds first and foremost to the trends that have already emerged in the marketplace. And to the extent that Greenspan sets policy actively, it's based on his appraisal of the long term, not a knee-jerk response.

So here's a Fed's eye view of what's happening now.

• Inflation is rising, but it's not as bad as it looks. Strong demand generated by the economic recovery is pushing up prices, especially for oil. But high productivity and lingering unemployment will restrain wage increases. And as Greenspan himself acknowledged in his speech, rapidly rising profits and the desire to gain market share are discouraging companies from passing higher costs through to consumer prices. If there's going to be a surprise down the line, it's that inflation will ease.
• The oil price could average less than $35 over the coming year. Recent record prices for oil were the result of a squeeze -- strong demand bumping up against below-average supply at a time when fears about Iraq were near a max. Once supply comes into better balance, there's room for oil to continue easing. It's also worth remembering that today's energy prices shouldn't be a problem for the economy: If you adjust for inflation, oil peaked at $82 a barrel in 1981 and gasoline was more than $3 a gallon.
• Short-term interest rates need to rise by about one and a half percentage points. Short rates normally stay within a band equal to recent inflation plus a small real return. At present, Treasury bill rates are a percentage point and a half below that expected level. Thus, any increase in short-term rates by the Fed now would simply be recognizing inflation that has already occurred. That inflation has been reflected in stock prices already. Any further market weakness would be the result of new inflation pressures, not the Fed recognizing past inflation.
• Most of the damage from higher long-term rates has already been done. Long rates normally stay within a band defined by inflation trends over the previous five to seven years plus a small real return. A year ago, yields on 10-year Treasury bonds were one and a half percentage points below expectations. Since then, 10-year T-bond yields have risen by more than a percentage point. Bonds and other fixed-income investments have already declined in price to reflect those higher yields. Any further uptick in long-term bond yields would probably be small, unless there is new, unanticipated inflation.
• Stocks should be poised for a new advance. Growth is good, earnings are good, productivity is good and hiring trends are good. The negatives are oil, Iraq (and fears of terrorism) and the imminent rise in interest rates. But oil is probably past its high and the U.S. is moving toward disengagement in Iraq. Most important, stocks have historically been able to surmount moderate interest rate increases early in a bull market. The chief risk (besides unpredictable terrorism) is a new and unexpected ratcheting up of inflation.

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From that perspective, whatever Alan Greenspan announces over the next three or four weeks is likely to be positive for stocks long-term, rather than a cause for concern. Fixed-income investments will face further losses if inflation worsens later on in the recovery.

But stock prices have already discounted existing bad news (that's what caused the recent correction). What really matters for stocks is that the Fed keeps an eye on inflation. Moderate increases in short-term interest rates should restrain any additional inflation pressures -- and from that point of view rate hikes would actually be bullish.

Michael Sivy is an editor-at-large for MONEY magazine. The Sivy on Stocks column and newsletter is available only to MONEY subscribers and AOL members. Subscribe now and you will also receive access to the Sivy 70 -- our exclusive list of America's Best Stocks -- and coming soon, to Sivy's Guide to Growth. Click here to subscribe to MONEY and to sign-up for the Sivy newsletter.