The incident, which happened around 9 p.m. Monday at a senior citizens complex on Monroe Street in Passaic, left the officer stabbed and a suspect shot.
The building also houses some people with disabilities or who are mentally ill.
Mayor Alex Blanco says officers responded to the building after receiving a report of a man creating a disturbance, which witnesses say began with a debate over a dollar bill.
When they arrived, they reportedly found a 26-year-old mentally disturbed man upset that a senior citizen would not give him the money. He also did not like the way the elderly man looked at him.
As officers tried to calm the situation, the man reportedly lunged at them with a large knife, stabbing one of them in the shoulder. Officials say the victim's partner then shot the man several times.
The officer, whose name was not immediately released, is in stable condition. The suspect is in critical condition at St. Joseph's Regional Hospital in Paterson.
Authorities say the suspect has had run-ins with police in the past.