The U.S. Federal Reserve cut its 2009 economic forecast sharply and discussed setting a target for inflation at its previous meeting as a deepening recession heightened fears of a dangerous decline in prices.

With employment falling sharply, the housing market showing no sign of stabilization, and credit conditions still tight, the central bank projected the economy would shrink by between 0.5 percent and 1.3 percent this year, according to minutes of the meeting that were released on Wednesday.

In October, the Fed's central tendency forecast for 2009 economic growth ranged from a decline of 0.2 percent to growth of 1.1 percent for this year.

The rapidly unraveling economy has pushed inflation below what many economists assume to be the Fed's comfort level, but the central bank stopped short of setting an explicit target for price stability.

Instead, for the first time, the Fed issued long-range projections that offered a view on how it expects the economy to perform beyond its normal three-year forecast horizon.

The projections, which will be issued quarterly, were included in minutes from the January 27-28 meeting of the policy-setting Federal Open Market Committee. They showed Fed officials thought inflation would remain abnormally low at least through 2010 and possibly into 2011.

Their longer-run projection called for inflation of 1.7 percent to 2 percent, well above the 2009 forecast for 0.3 percent to 1 percent and an indication of the inflation rate officials would like to achieve.

The longer-term projections of inflation may be interpreted ... as the rate of inflation that FOMC participants see as most consistent with the dual mandate given to it by Congress -- that is the rate of inflation that promotes maximum sustainable employment while also delivering reasonable price stability, Fed Chairman Ben Bernanke told the National Press Club.

Taking on-the-record questions from the media for the first time since becoming Fed chairman, Bernanke said the long-run projections should help anchor the public's expectations about the future path of inflation in a way that could help prevent a self-feeding inflationary, or deflationary, psychology.

When Bernanke took the helm at the Fed in 2006, he was a vocal proponent of setting a numerical target for inflation. However, that has been a subject of much debate among other Fed officials, some of whom worry that setting an explicit target would limit the central bank's flexibility.

But with the central bank increasingly concerned that falling prices will trigger a dangerous round of deflation and prolong the recession, some economists had speculated the Fed would extend its forecast horizon to provide a signal on where it thinks longer-term inflation should be.

The minutes showed that Fed officials held a January 16 conference call where they discussed establishing an explicit inflation target, but no decision was made.


In his remarks, the Fed chairman disclosed no new programs to aid the economy. Nor did he mention buying longer-dated Treasury debt, which he discussed in January as a way to ease borrowing costs but has made no public mention of since. That has led some observers to conclude the Fed was backing away from the idea.

There was also scant discussion of that option contained in the minutes, even though the Fed, in a statement following the January 27-28 meeting, had said it was prepared to take that step if it thought it would be particularly effective in tight conditions in private credit markets.

Bernanke said aggressive steps the Fed had taken to combat the financial crisis were paying off as evidenced by lower borrowing costs in markets for commercial paper and mortgages.

These policies appear to give the Federal Reserve some scope to affect credit conditions and economic performance, notwithstanding that the conventional tool of monetary policy, the federal funds rate, is nearly as low as it can go, Bernanke said.

He acknowledged concerns that the Fed's lending programs, which have more than doubled its balance sheet to about $2 trillion, exposed taxpayer money to greater risk, but said the Fed had acted appropriately to limit potential losses.

He also dismissed concerns that expanding the Fed's balance sheet would stoke inflation, pointing out that with global economic activity so weak and commodity prices low, there was little risk of unacceptably high inflation in the near term.

However, at some point, when credit markets and the economy have begun to recover, the Federal Reserve will have to moderate growth in the money supply and begin to raise the federal funds rate, he said.

(Writing by Emily Kaiser, Editing by Chizu Nomiyama)