When the Federal Reserve began cutting interest rates in January, there was little doubt about the direction it should be going. The economy was in a steep dive. Recession seemed likely. Bold action was needed soon.

Now, six months later, the Fed is winding up its rescue effort amid a sea of uncertainty. While the economy has stopped sinking, it isn't yet clear whether it will re-float smartly. Recession remains a possibility. Inflation looms as a threat.

That will make the Fed's next decision on interest rates, at a meeting on June 27, one of the diciest in recent months. Not only is the central bank sailing on uncharted waters, it risks steering a course that might easily run it aground.

"The risks are substantial," said Ira Kaminow, economist at Capital Insights Group, a Washington consulting firm. "The Fed already has done a lot. It's looking to see whether it's done enough"

The prospect that the debate will be all over the lot reflects the confusion over where the economy is headed. On one hand, businesses have worked off much of their excess stockpiles. So far, consumer spending and housing have held up.

Little good news

Beyond that, however, there's little good news. Capital investment remains weak. Profits are being squeezed. Household wealth has plummeted over the past couple of quarters, and many analysts are worried that consumer spending soon may collapse.

Just as worrisome to some economists is that inflation has begun to stage a comeback. While some price indexes are well-behaved and consumer prices are creeping up steadily.

"While the Fed has talked a good game contending that inflation is 'contained,' the numbers themselves don't look to me like that is the case," said Randell Moore, head of Blue Chip Economic Indicators.

Compounding the Fed's problems is that policy-making is at a difficult juncture. After five cuts in interest rates this year that pushed down the overnight bank lending rate by 2 1/2 percentage points, the Fed has pumped substantial stimulus into the economy.

The central bank also has been expanding the money supply. Fed statistics show that M2 the most widely followed measure of money has been growing at a 10 percent to 14 percent annual rate during much of the first half of this year. That's given the economy a boost beyond that provided by lower interest rates.

Anyone's guess

The difficulty is, with the traditional lags, policy makers won't know for several more months whether the stimulus has been sufficient to spur a recovery, or is so excessive that it risks re-igniting inflation. Right now, the answer is anyone's guess.

Complicating that analysis is the just-enacted tax cut, which will further stimulate growth. Ordinarily, Fed policy makers ought to be able to factor in the tax-cut effects. Yet, analysts are divided over what impact it may have.

Looming in the background is a fundamental question: Will the past five years' gains in productivity continue?

Productivity growth has fallen off in recent months as the economy has slowed, and analysts are divided over how much of it There's also another factor: The dollar's continuing rise puts more pressure on the Fed to cut interest rates further. If it doesn't the U.S. currency may come under even more strain, risking a precipitous plunge in the dollar's value later.

To some analysts, one big question that Fed policy makers must resolve is how serious the threat from inflation will prove over the next few months. Settling that will tell them how much more stimulus is safe.

In recent weeks, policy makers have been playing down any inflation threat, contending that price pressures have been "contained."

How much of the Fed's blase attitude reflects Chairman Alan Greenspan's real view and how much is just an attempt to prepare the markets for further rate cuts remains to be seen, said Paul Kasriel, economist at Northern Trust Company of Chicago.

"While they say that inflation is contained, I'm not sure that everybody outside believes it," Kasriel said. "If they ease very much, there could be some concern about the possibility that they are not really containing inflation as they say."

Hedging bets

As if to underscore the difficulty of this week's decision, investors have been hedging their bets on what the central bank will do. Predictions range from an interest-rate reduction of a quarter of a percentage point to a half point.

One difficulty is that since Wall Street already expects the Fed to reduce interest rates further, forgoing additional cuts entirely would risk sending stocks into another slump, which might heighten pessimism among businesses and consumers.

Meanwhile, you can pick your forecast. Private economists are churning out predictions that cover the gamut, from a recovery to a prolonged slowdown or even a recession. They also have a wide range of bets on what Fed policy makers will do.

"That's what we pay them the big bucks for," Kasriel quipped.

Art Pine is a columnist for Bloomberg News.

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