Ever since its creation in 1913, the Federal Reserve has grappled with a daunting political contradiction. The Fed is charged with preventing the collapse of the banking and financial system, whose health is essential for the "real economy" of production and jobs. But financial bailouts usually occur when mistakes or misdeeds by bankers and investment professionals make them public pariahs. To do its job, then, the Fed protects -- or seems to protect -- an unpopular, disgraced and undeserving group. We are now witnessing this contradiction in full bloom.

The Fed has become a congressional scapegoat for assorted economic frustrations: 10.2 percent unemployment; expensive rescues of fragile financial institutions (AIG, Bear Stearns, Citigroup); outsize Wall Street bonuses; and the...