"Policy traction" is an expression that lately has come into fashion. In essence, it refers to the relationship between the size of the monetary and fiscal stimulus injected into an economy...and its effect upon economic growth and employment.

In the past three years, America has experienced an interest rate collapse, a record fiscal stimulus and the loosest monetary policy imaginable...all of which fueled money and credit creation at a scale that has no precedent in history. Has it really worked?

Well, in one way this policy of stimulus has had fabulous traction: It has engendered the greatest credit and debt bubble in history. Total outstanding debt, financial and non-financial, in the United States has ballooned by almost $6,500 billion since 2000, as against GDP growth of $1,238 billion. For each dollar added to GDP, there were about six dollars added to indebtedness.

Policy traction also surfaced in a second way: The runaway money and credit creation went with a vengeance into asset markets - stocks, bonds and housing. When the equity bubble popped in early 2000, the consumer simply moved on to the housing bubble that had been waiting in the wings, helped by the Fed-inspired bond bubble driving mortgage rates sharply downward.

The result was an unprecedented mortgage-finance excess. While businesses were slashing the consumer's income growth, the consumer offset this income loss largely by stepping up his borrowing.

Yet in the course of 2002, it became clear that the lowest short-term interest rates in nearly half a century were failing to create the customary strong economic recovery. In June, the Fed cut its interest rate for the 13th time, to 1% - a 45-year low. In the following month, it admitted in its report to Congress that U.S. economic performance during the first half of the year had remained sub-par.

On the other hand, however, the Fed stressed the success of its easing policies by mentioning the recent rise in stock prices, the sharp narrowing of credit spreads on corporate debt, the strong housing and mortgage refinancing market and rising consumer sentiment.

What, in fact, had emerged was an unprecedented dichotomy between the economy and financial markets in the effects of the Fed's aggressive monetary easing. Instead of jump-starting consumer and business spending, the Fed's extreme monetary looseness and rock-bottom short-term interest rates generated multiple price bubbles in the stock, bond, mortgage and housing markets.

Without inspiring controversy, the U.S. economy has been shifting to a growth model that radically differs from past experience. In the old model, which has ruled for centuries, monetary easing was conceived to work directly on the real economy and it could be counted upon to do so promptly.

But the old model functioned in a world of low debts and strong employment and income growth. More importantly, it was a world in which financial systems of very limited size principally served as mere conduits for channeling savings into capital investment, creating national wealth in the form of productive plant and equipment, and commercial and residential buildings.

Faced with an economy that responded poorly to its aggressive monetary easing, and with very little scope for further cuts in short-term interest rates, a desperate Fed searched for an action to take. Internally, it was obviously considering an attempt to increase policy traction by bringing long-term rates down still further. But it hesitated to intervene directly.

So, the Fed reacted in an unconventional way. It put America's highly vigilant, huge, financial and speculative community before the cart...by using nothing more than simple opportune rhetoric. Repeated public talk by Mr. Greenspan and other Fed members of looming deflation in the economy was one bit of bait. Simultaneous talk of two new policy considerations was the other.

The first idea was to repeat in public an explicit commitment to maintain the existing rock-bottom short-term rate peg of 1% as far "as the eye can see." The other one consisted of public hints that "unconventional" measures, like direct purchases in the market, were being considered to push long-term rates further down as well.

The Fed's rhetoric was really an unreserved invitation to investors and speculators around the world for greater engagement in playing America's yield curve with a heavily leveraged carry trade. Many heard and acted promptly. In just six weeks, U.S. 10-year yields fell from 3.9% to 3.1%.

It should, by the way, be clear that this manipulated indirect intervention vastly outperformed what the Fed could have possibly done with direct bond purchases. We have no idea about the scale of the purchases that suddenly flooded the U.S. bond market, but it was without question in the range of several hundred billion dollars.

What followed is well known: A frenzied stampede of the financial community into the highly leveraged bond carry trade sent bond yields plummeting, pulling in their wake highly correlated mortgage rates sharply downward with them. In the same vein, the loose money helped to boost house prices. Given, in addition, extremely aggressive mortgage lending institutions, eager to lend prodigiously against rising house prices...consumer borrowing just went parabolic.

All in all, four interrelated bubbles have kept the U.S. economy going after the bursting of the stock market bubble in 2000: Rising house prices, falling bond yields, falling mortgage rates, and soaring mortgage loans all fed the consumer spending binge.

Yet the key role fell manifestly to the bond bubble. By pulling mortgage rates precipitously down, it provided the big bait that lured homeowners to capture the offered big savings in current interest rate service by refinancing and increasing their mortgage.

U.S. economic growth, therefore, is no longer based on saving and investment. Credit excess has provided soaring collateral for still more credit excess, creating still more asset inflation for still more borrowing and spending excesses. It is a perpetual motion machine that just goes on cranking out wealth and spending.

The traction that these policies have so far achieved, and its probable economic and financial effects in the longer run, have therefore become the most important issue in the current development in the United States.