As it seeks to slow U.S. economic growth, the Federal Reserve is experiencing an acute example of what psychologists call "cognitive dissonance." On the one hand, the latest business data--from housing to exports to inventories--point to a robust economy. On the other, the money supply refuses to grow. Indeed, M2, the most closely watched monetary aggregate, fell in both August and September.

So what's a befuddled Fed to do? For the moment, it is trying to rein in the one area of financial activity that is taking off: bank lending. After declining for more than three years, banks' commercial and industrial loans have surged this year. And bank consumer loans, including installment credit, have also been expanding briskly.

Testifying before Congress recently, Fed Chairman Alan Greenspan pointedly noted that banks are relaxing their business-lending standards. And at the annual American Bankers Assn. meeting in October, he echoed the same theme.

The problem, warns economist Carol Stone of Nomura Securities International Inc., is that businesses and consumers are actually taking on less debt than the bank-lending data suggest. "While C&I lending has exploded recently," she notes, "commercial paper has been flat since June, and corporate bond issuance is also down this year." Thus, total business-debt growth is still relatively subdued.

Similarly, Stone notes that surging household installment credit has been offset by waning mortgage growth and other types of household borrowing. And economist Edward S. Hyman of ISI Group Inc. theorizes that much of the rise reflects two mitigating trends: growing convenience use of credit cards for small purchases, such as groceries and movie tickets, and heightened use of cards instead of checks to pay for big-ticket items in order to obtain frequent-flier miles and other discounts offered by card issuers.

In sum, observes Stone, it's hard to reconcile the modest pace of overall debt growth with fears of an overheating economy. "If the Fed decides to tighten further," she says, "the impact on economic activity could prove far more restrictive than it expects."

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