Minutes of the Fed's latest policy meeting in January suggested officials remain positive about the economy's prospects even as they worry about the impact of an elevated unemployment rate, which they see holding near the current 9.7 percent through 2010.
The minutes offered a window into the Fed's thinking on how best to withdraw the extraordinary stimulus it has provided the economy, but also revealed substantial disagreement among officials on the timing and sequencing of exit steps.
To combat the worst recession and financial crisis since the 1930s, the U.S. central bank has cut benchmark interest rates to near zero and bought more than $1.5 trillion in government and mortgage bonds to pump money into the economy.
Several thought it important to begin a program of asset sales in the near future to ensure that the Federal Reserve's balance sheet shrink more quickly, the minutes of the January 26-27 meeting said.
Others policymakers, however, appeared worried that dumping mortgage debt into a fragile market might drive up mortgage rates, compromising the housing sector's tentative stabilization. Housing starts rose 2.8 percent in January but at 591,000 a year still stood at barely a quarter of their boomtime peak.
At the January meeting, the Fed held benchmark overnight interest rates near zero and reiterated a pledge to keep them extraordinarily low for an extended period.
Kansas City Federal Reserve Bank President Thomas Hoenig dissented at the meeting because he was uncomfortable with the low-rate pledge. The minutes showed that he did not want to drop the vow altogether but simply tone it down.
There was no clear evidence in the minutes that his dissent had much sympathy within the Fed's policy committee, but Philadelphia Fed President Charles Plosser said on Wednesday the language could curtail the bank's wiggle room.
The consensus seems to be shifting, said Marc Pado, U.S. market strategist at Cantor Fitzgerald in San Francisco. This is step one for Fed watchers, but we're still several meetings away from a rate change.
U.S. stocks briefly pared gains, the dollar rose and U.S. government debt prices extended losses after the minutes were released as investors braced for an eventual tightening in Fed monetary policy.
THE SLACK DEBATE
Underlying the internal discord on the Fed's exit strategy are fundamental differences in economic theory. Officials diverge on how much a weak labor market and untapped productive capacity will dampen inflation.
The minutes showed officials do not believe a pickup in underlying inflation is an immediate concern, although many voiced anxiety that commodity prices could rise as the global economy gained traction, sparking broader inflation.
The Fed's quarterly economic forecasts contained in the minutes were not radically changed from projections released in November, but were nonetheless slightly more optimistic.
Officials see U.S. gross domestic product rising between 2.8 percent and 3.5 percent this year, on the firmer side of the projections of private sector economists. Previously, the forecast range was 2.5 percent to 3.5 percent.
U.S. GDP grew at an annualized 5.7 percent pace in the fourth quarter, but few analysts expect that to be sustained.
In general, participants saw the upside and downside risks to the outlook for economic growth as roughly balanced, the minutes said.