Given the current state of the economy, the members of the Federal Open Market Committee (FOMC), the Federal Reserve’s rate-setting arm, could easily justify either raising rates to head off inflation or lowering them to strengthen an anemic economy. What they actually did at the Committee’s most recent meeting was let rates stand where they were, holding the federal funds rate steady at two percent.

Explaining its decision to hold the line, the Committee released a statement that made clear it is caught between two hazards — inflation and recession. “Economic activity expanded in the second quarter,” the Committee noted, “partly reflecting growth in consumer spending and exports.” That’s good.

However, the FOMC statement went on, “Labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters.” That’s bad.

Better Times Ahead

The Committee was surprisingly confident about the future. “Over time,” it declared, “the substantial easing of monetary policy” that the committee had already achieved, “combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.”

True, inflation has been high, “spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated.” Nonetheless, the Committee said it “expects inflation to moderate later this year and next year.” (The Committee persisted in this expectation even though it acknowledged that the inflation outlook “remains highly uncertain.”)

The FOMC concluded, “Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”

Inflation Worries Growing

It seemed clear that inflation worries were more pronounced in the August policy statement than in earlier statements, with a promise to act as decisively on rising prices as it would on signs the economy is slipping into recession.

American Bankers Association economist Keith Leggett said this likely means the FOMC members would carefully review new price data as it comes in. “But all data coming in is lagging and that’s the problem,” he said.

Still, it was important to some of the Federal Reserve Bank presidents on the Committee to take a strong stand against the price increases they fear are turning into self-sustaining inflation expectations. “As soon as they see the whites of inflation’s eyes, they’re going to fire,” said Leggett.

Indeed, one Committee member thought that his colleagues should have opened fire on inflation earlier. Richard W. Fisher, the President of the Federal Reserve Bank of Dallas, voted against the Committee resolution, preferring to increase rates to head off inflation — a position he had already staked out by dissenting from every FOMC policy statement so far this year.