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Fed saw equal risks in inflation, lack of growth

Even in the midst of a severe meltdown, Federal Reserve officials at their September meeting believed the risks from weaker growth and higher inflation were roughly equal.
/ Source: The Associated Press

Even in the midst of a severe meltdown on Wall Street, Federal Reserve officials at their September meeting believed the risks from weaker growth and higher inflation were roughly equal.

The Fed officials discussed the financial turmoil during their closed-door meeting on Sept. 16, according to minutes released Tuesday. The meeting occurred a day investment bank Lehman Brothers collapsed — the largest bankruptcy in U.S. history. It was also hours before the Fed announced it was extending an $85 billion loan to rescue American International Group, the world’s largest insurance company.

While concluding that it would not change interest rates at the September meeting, the minutes showed some members said a policy response from the central bank might be needed.

Fed Chairman Ben Bernanke and his colleagues left the federal funds rate unchanged at 2 percent and kept the portion of the public statement discussing future actions balanced between worries about economic growth and inflation.

The Fed’s action disappointed many investors. They had been hoping for a stronger signal at the September meeting that the central bank was prepared to cut rates given the turbulence rocking Wall Street.

Only two days after the Fed meeting, Bernanke and Treasury Secretary Henry Paulson traveled to Capitol Hill to tell congressional leaders at a private meeting that the credit strains had become much more dire and emergency legislation was needed.

That plea resulted in the passage on Oct. 3 of the largest government bailout in history, a $700 billion package that will allow the government to buy bad mortgage-related debt off the books of financial institutions. The goal is to get financial companies to resume more normal lending.

In a speech Tuesday, Bernanke signaled the continued turmoil in financial markets had moved the central bank closer to cutting interest rates.

Bernanke said the financial crisis had darkened the country’s current prospects and was likely to prolong its economic malaise. He said the Fed will need to consider whether its current stance of holding interest rates unchanged “remains appropriate.”

In the minutes, Fed officials had sounded a more upbeat tone, expressing hope that the government’s takeover of mortgage giants Fannie Mae and Freddie Mac on Sept. 7 might help stabilize mortgage markets and give a boost to the beleaguered housing sector.

The minutes showed that Fed officials in September were still anticipating the possibility of future rate increases.

“With elevated inflation still a concern and growth expected to pick up next year if financial strains diminish, the committee should also remain prepared to reverse the policy easing,” the minutes said.

Private economists believe that the severe financial turmoil all but guarantees that the country will slip into a recession. They expect that will force the Fed to cut interest rates, beginning with the Fed’s next meeting on Oct.28-29 or perhaps in an emergency move before that meeting.