The Federal Reserve, it appears, is preparing to use a blunt-edged hammer on the U.S. economy -- higher interest rates -- to solve an imaginary problem of domestic price inflation. Meanwhile, the central bank ignores the regulatory tools that can counter the real threat to our current prosperity -- Wall Street's dangerous bubble of inflated stock-market prices.

Instead of punishing the entire economy, the Fed ought to target the easy credit that banks are providing to financial investors -- the fantastic borrowing used to buy more stocks and other financial assets. Wall Street's credit binge is part of what's driving the "irrational exuberance" once lamented by Fed Chairman Alan Greenspan. But the Fed itself is implicated in these excesses.

With a measured application of credit restraints, the Fed might succeed in defusing this unstable situation gradually, rather than violently through a full-blown panic and crash. There are two measures at the Fed's disposal for easing us back from the brink.

First, raise the 50 percent margin requirements on financial investors, who can now borrow $500 for every $1,000 they invest in stocks. Second, impose on banks a special reserve requirement against their lending to financial firms and their customers. If the Federal Reserve merely starts talking about using such direct restraints, it will knock some zeal out of Wall Street's overly optimistic expectations.

What we will see, more likely, is the Federal Reserve once again punishing the innocent (wage earners) for the excesses of the mighty (high rollers on Wall Street). If the central bank does raise interest rates at its meeting this week, as the market chatter predicts, the move will be intended to increase unemployment by slowing economic growth. That tamps down wages for average workers. Wages are the Fed's real target.

This is unjust in any season. Right now, given the fragility of the global economy, it may also be dangerous. Cooling down the world's one vibrant economy puts more downward pressures on the other nations struggling to recover from crisis. Higher U.S. interest rates force many others to raise their rates too. Dampening demand in America means the United States cannot serve as "buyer of last resort" for exports from those battered economies.

While the public rationale invokes the old ghost of inflation, a more sophisticated argument goes like this: The inflation talk is a cover. What the Fed really worries about privately is the stock market's bubble and how it could end in disaster -- a meltdown if the bubble collapses abruptly.

Last fall, when financial markets were scared and swooning, the Fed's three emergency rate cuts renewed the giddy optimism and instilled an unintended conviction among investors: If anything goes wrong, the Fed will come to our rescue with more rate reductions. To puncture this false confidence, it is said, the Federal Reserve wants to raise rates modestly -- a symbolic nick to sober up the crowds of overexuberant players.

The trouble is, if this doesn't work and the stock-price bubble keeps expanding, the Fed will be pushed to do more of the same: a series of rate increases that could drive American producers and consumers to the brink of recession, while smashing any hopes for recovery elsewhere in the world. Why send oblique signals to Wall Street when the Fed can address the problem directly?

In the past two decades, driven by the free-market ideology of deregulation, the central bank has steadily backed away from asserting credit restraints on financial markets or banking. It reduced or eliminated reserve requirements for banks. At one point, it even suggested the repeal of margin rules for stock purchases. This laissez-faire era of credit regulation has produced an astonishing tidal shift in favor of the financial markets.

A decade ago, financial firms accounted for less than 30 percent of the total annual borrowing in U.S. credit markets, but they now consume 54 percent -- more than all the traditional borrowers from industry and commerce. This little-noted mushrooming of credit for financial transactions has been documented by economist Jane D'Arista, associate director of the Financial Markets Center in Virginia.

D'Arista found that, between 1992 and this year's first quarter, business sectors expanded their aggregate debt by 36 percent, while the financial sector's debt grew by 124 percent. "Indeed, the amount of credit now required to accommodate U.S. financial activity may be stronger evidence of a bubble than asset prices themselves," she wrote.

While D'Arista sees many other forces driving this expansion, one element is obvious: Brokers and their clients are borrowing more on margin to buy still more stocks in the fast-rising bull market.

In short, despite conventional wisdom, the Federal Reserve's lax hand as a regulator is directly implicated in the creation of the financial bubble. The central bank has a responsibility -- and the power -- to do something about it.

William Greider, author of "Secrets of the Temple: How the Federal Reserve Runs the Country," writes for Rolling Stone.