A Bit of Stagflation

The Fed sees slower growth and more inflation.

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At a January 29-30 meeting, just a bit over a week after slashing interest rates by three quarters of a point, Federal Reserve officials decided to cut again by an additional half a point. Today, newly released minutes from that meeting offer hints at why they made the biggest cuts in interest rates in recent memory.

Lower growth: Fed policymakers saw fourth-quarter growth in gross domestic product slowing to between 1.3 percent and 2 percent, down from an earlier estimate of 1.8 percent to 2.5 percent. (The Commerce Department's initial growth estimate for the quarter, released January 30, was even worse—a meager 0.6 percent.) Economists agree that cooling could easily sink into negative and possibly recessionary territory.

Higher inflation: The Fed expects both headline and "core" inflation (excluding food and energy prices) to rise enough to boost its favorite inflation measure to a range of 2 percent to 2.2 percent. That puts inflation above the Fed's unofficial "comfort zone"—and would normally prompt higher interest rates if not for fears that higher rates would send the wider economy into a tailspin.

The minutes show the Fed also worried that its big January 22 rate cut, which had coincided with the threat of a big drop in the stock market, would look as though the Fed was pandering to equity markets. Fed officials decided to cut anyway, reckoning that the cost of a little credibility outweighed the immediate threat of a reeling economy.