Fed minutes show debate on economic outlook

NEW YORK (CNNMoney.com) -- The Federal Reserve is the last line of defense against a weakening economy, but there has been sharp disagreement among members over what action the central bank should take.

Minutes from its most recent meeting released Tuesday show that Fed policymakers openly worried about the impact of its latest move: reinvesting the proceeds of maturing mortgages and debt into U.S. Treasurys. It's a step that keeps the Fed's $2 trillion balance sheet intact, and keeps money flowing through the U.S. economy.

Some members worried the policy could send a dangerous message to markets of bigger intervention to come. But other members worried the limited purchases would not be enough to help the economy.

Several members stressed that the Fed needed to "consider steps it could take to provide additional policy stimulus if the outlook were to weaken appreciably further." And the Fed minutes stated the Fed might soon move to buy additional mortgages, rather than just Treasurys, if conditions worsened.

"While reinvesting in Treasury securities was seen as preferable given current market conditions, reinvesting in [mortgage-backed securities] might become desirable if conditions were to change," said the minutes.

The debate was closely watched for some indication that the Fed is ready to take action to keep the shaky U.S. recovery on track.

But Fed watchers said the amount of debate and dissent in the minutes suggest the central bank is not ready to make any major change in policy anytime soon.

"Fed officials were clearly caught off-guard by the extent of the slowdown...but are still sticking to the line that growth will accelerate next year," said Paul Ashworth senior U.S. economist for Capital Economics in a note to clients Tuesday. "The Fed will only restart its asset purchases if economic conditions deteriorate markedly from where we are now."

Lyle Gramley, a former Fed governor who is now senior economic advisor with Potomac Research Group, said the debate within the Fed isn't something to be worried about.

"I think the divisions have been there all along," he said. "They're just becoming more pronounced now as the economy shows additional troubles."

But he said the biggest worry from the minutes is that even the Fed members who believe more action is needed don't have a lot of good choices available to them.

"Even if they agree to do something, it's not at all clear that it would do much good," he said.

Still, the Fed appears more ready to act than Congress does, said Jay Bryson, global economist for Wells Fargo Securities.

"If the economy deteriorates further, the Fed will do the right thing," he said. "There might be dissent, but the center of gravity is still in favor of doing what is necessary. And it's a lot easier to get 12 people to more or less agree than it is 535 people."

Despite the debate, only one member officially voted against the final decision: Kansas City Fed President Thomas Hoenig, who has long expressed concern that the Fed risks restarting inflation if it doesn't start to reduce the money it has pumped into the economy.

All of the Fed officials believe the economy continues to recover, and they are not overly worried about the risk of deflation -- a steady fall in prices resulting in stagnant growth. "No member saw an appreciable risk of deflation," said the minutes.