The Federal Reserve is required by the Federal Reserve Act to provide an elastic currency.
The historic collapse of Bear Stearns shows that the Federal Reserve is not providing an elastic currency in the economy.
The Federal Reserve is trying to solve the credit crisis but is taking the wrong steps.
The Fed keeps trying to loan money to the financial system but that does not provide an elastic currency unless the Fed writes-off the loans and does not demand repayment or payment of interest on the loans.
Loans do help but not in the manner that the credit markets currently need.
They need to go into the Open Markets and buy securities until it has replaced all the cash lost from the system from the write-downs at all financial institutions.
The Fed will pay for the securities it buys with cash and that will replace the lost money from the Economy. Such action will not cause inflation as long as the Fed is simply replacing money that was once already in the system. If the Fed goes to far and starts adding money that was not already once in the system then they will cause inflation by inflating the amount of money in circulation. This may sound complicated but is really simple.
Had the Federal Reserve taken such action at any time during the Great Depression it would have ended the Great Depression. But the Fed never did. In fact in the early 1930’s Congress debated a bill which would have required the Fed to take such action. Had the bill been passed the Great Depression would have ended.
But the Federal Reserve pulled a fast one on Congress by promising to take the action without legislation but they never did. And most of the Congressional sponsors of the bill were thrown from office in 1932 elections due to the bad economy.
Congress today could also pass a bill that would require the Federal Reserve to replace the lost money from the economy but given the current leadership (or lack thereof) in Congress this seems highly unlikely.
In order to end the current credit crisis The Federal Reserve must go into the Open Markets and buy securities until it has replaced all the money that has been lost in the economy.