The Federal Reserve, releasing its first forecast on the economy, is expecting slower growth and lower inflation next year.
But minutes from the Fed's October meeting show policymarkers were reluctant to cut interest rates further despite signs of a worsening housing slump and credit crunch.
Stocks tumbled intiallyas hopes faded for a December rate cut, but the market later rallied to close higher.
In a new step toward greater transparency, the Fed released a summary of its economic projections through 2010 along with the minutes of the October policy meeting.
The Fed projected U.S. growth to slow to a range of 1.8%-to-2.5% in 2008, down sharply from the 2.5%-to-2.75% growth forecast in June. The lower forecast reflected tighter credit, weakness in housing and rising oil prices, a summary said.
The Fed also is aiming for inflation of 1.5 percent to 2.0 percent over the medium term, in the clearest signal yet of an unofficial inflation target.
Rate Cut "Close Call"
In its October meeting, the Fed debated whether it needed more evidence the economy had been damaged by the housing slump and market turmoil before deciding to cut rates as an insurance policy, minutes of the meeting show.
"Many members noted that this policy decision was a close call," the minutes said.
The U.S. central bank trimmed benchmark interest rates by 0.25 percentage point to 4.5 percent at its Oct. 30-31 meeting, making for a total of 0.75 point rate reductions at the last two meetings.
Policy-makers opted for the October rate reduction because tighter credit had made the stance of monetary policy somewhat restrictive, the minutes said.
Fed members worried about financial markets that were still showing stress from concerns about bad credit.
Markets Still Fragile
"Participants generally viewed financial markets as still fragile and were concerned an adverse shock ... could further dent investor confidence and significantly increase the downside risks to the economy," the Fed said.
The Fed under Chairman Ben Bernanke has debated adopting an explicit inflation target, but concluded that it should not pursue that option at this stage.
It has, however, decided to offer quarterly economic forecasts that will span three years. In doing so, policy-makers are providing a clear idea of what inflation level they hope their interest rate decisions will deliver, and how quickly they think it is appropriate for the Fed to get there.
In addition, the summary of economic projections over the next three years to 2010 also exposed a sharp increase in concerns on economic growth in 2008, compared with June
The Fed was more sanguine on inflation, expressing some confidence that recent moderation on core inflation, which strips out energy and food prices, could be sustained.
At the same time, policy-makers saw factors including soaring oil prices and the weakening dollar as having the potential to put upward pressures on core prices in the near term.
Moreover, Fed officials worried that persistently higher readings for overall inflation could unhinge inflation expectations, which have to date remained well contained.
They have said since the October meeting they believe the two rate reductions should be sufficient to buffer the economy as it enters a rough patch that may last into next year.
That stance is at odds with financial markets, which generally expect the Fed to lower rates to 4.25 percent at its next policy meeting on Dec. 11. Implied prospects for a December Fed ease were as high as 96 percent late Monday but dipped to 84 percent before the minutes as housing construction data offered a glimmer of hope for the battered sector.