Slow Economy, High Prices Raise Specter of Stagflation

Nonetheless, rising prices put the Federal Reserve in a bind. It has launched an aggressive interest rate cutting campaign to try to keep the downturn in the economy from becoming a severe, prolonged recession.

But those steps to spur the economy could make it harder for the central bank to fight inflation, particularly if ordinary businesses and individuals come to expect that high prices in the past year will become the normal state of things.

For now, leaders of the central bank appear more inclined to keep cutting rates to ease the downturn in the economy than to reverse course.

"I do not expect the recent elevated inflation rates to persist," Donald L. Kohn, vice chairman of the Fed, said in a speech yesterday. "The adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare in the United States."

Kohn's expectation that inflation will moderate is based on an assumption that commodity prices will level off, and that the slower economy will reduce upward pressure on wages.

He and other leaders of the Fed have taken solace in data and surveys that suggest Americans do not expect inflation to remain high. "Inflation expectations remain reasonably well anchored," Kohn said yesterday.

Chairman Ben S. Bernanke is to testify on Capitol Hill today and Thursday, and will likely express similar ideas, as he did in congressional testimony two weeks ago.

But others in the Federal Reserve system appear to be more worried, and as a result, less inclined to continue the rate cutting campaign.

"It's not enough in my opinion, to assume that if we slow down domestically here that that will give us the relief that we would like to have . . . on the inflationary front," Richard W. Fisher, president of the Federal Reserve Bank of Dallas, said on PBS's "Nightly Business Report" yesterday. Fisher dissented from the Fed's decision to cut interest rates by half a percentage point on Jan. 31.