The minutes from their Oct. 24-25 meeting, released Wednesday, revealed that in their discussions about the economy's health and even as they decided to hold interest rates steady, the Fed members worried more about the risk of inflation than the danger of the economy cooling too much.
"All members agreed that the risks to achieving the anticipated reduction in inflation remained of greatest concern," the Fed minutes said.
On Wall Street, stocks rallied as the minutes reassured investors that the Fed had inflation in hand. The Dow Jones industrials scored another record close, gaining 33.70 points to finish at 12,251.71.
The minutes also revealed that Fed policymakers debated the pros and cons of "inflation targeting" — numerically spelling out acceptable bounds for inflation. No decisions were reached and the discussion was expected to be resumed in 2007 at the at the Fed's first meeting of the year in late January.
Ben Bernanke, who took over as Fed chairman in February succeeding Alan Greenspan, favors the notion of an inflation target and believes it would help the central bank communicate more effectively with Wall Street and Main Street.
Even with their concern about inflation risks, Fed policymakers still stuck to their forecast that slowing economic growth and a calming down of once surging energy prices will eventually lessen inflation pressures.
"Nearly all members expected that the economy would expand close to or a little below its potential growth rate and that inflation would ebb gradually from its elevated levels," the minutes stated.
Some recent inflation barometers released since the Fed's October meeting have suggested that inflation is settling down.
The government reported on Tuesday that wholesale prices fell by a record 1.6 percent in October. The government will release a report on consumer prices on Thursday.
Although substantial uncertainty continued to attend the Fed's outlook, "most members judged that the downside risks to economic activity had diminished a little, and likewise, some members felt that the upside risks to inflation had declined, albeit only slightly," the minutes said.
The October session marked the third Fed meeting in a row where a key interest rate was held steady at 5.25 percent.
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, Va., was the lone dissenter at all three meetings. Lacker said he would have preferred that the Fed increase interest rates by one-quarter percentage point.
The minutes said that Lacker believed such action was necessary to ensure that core inflation, which excludes food and energy prices, "declines to an acceptable rate in coming quarters."
At the October meeting, the Fed didn't close the door to another rate increase. The Fed minutes said that most participants expected inflation to moderate gradually, but they were "quite uncertain as to the likely pace and extent of that moderation."
Even so, many economists predict the central bank will leave rates alone once again when it meets next on Dec. 12.
"The Fed is sending a message that even though they are sidelined, they are very much aware of how inflation is acting. The Fed is on top of things, and the markets shouldn't be worried," said Richard Yamarone, economist at Argus Research.
The minutes suggested that a rate cut any time soon remains unlikely, analysts said. Some predict the Fed will slice rates sometime next year.
The Fed's goal is to slow the economy sufficiently to thwart inflation but not so much as to cripple economic activity.
Until halting its rate-raising campaign for the first time in August, the Fed had boosted interest rates 17 times since June 2004 to fend off inflation.
In the summer, economic growth slowed to a 1.6 percent pace, the most sluggish in more than three years. The housing slump was a main factor in the slowdown.
Fed policymakers said the housing slump was likely to remain a "substantial drag on economic growth over the next few quarters." However, many believed that the housing cooldown was "likely to be no more severe than they had previously expected and that the risk of an even larger contraction in this sector had ebbed."