The Federal Reserve, in a remarkable acknowledgement of how soft the economy is, has disclosed a vote of its open market committee to keep short term interest rates close to zero for at least three more years—until late 2014. This means that the Fed will keep pumping money into the economy by purchasing bonds at whatever level is required.

The Fed, improbably enough, has also been pressing the Obama Administration to do more about the housing bust, arguing that its own cheap money policies can only do so much. The climate of very low interest rates means that the new program announced by President Obama in the State of the Union Address making it easier for homeowners to refinance—details still to be disclosed—will have several years to lower housing costs and perhaps help put a floor under housing prices. But the Administration needs to do a great deal more so that under-water homeowners can refinance at the current depressed market value of the house.

It is rare to see the Fed taking positions to the left, as it were, of a Democratic administration. That shows that the Fed is less captive of the financial industry than it once was—and that the Administration is disappointingly too captive of it.

The Fed action suggests that our central bank’s leaders are worried—about continuing deflation, and about the huge risks coming to the global economy from Europe. It is only in the last couple of weeks that the new head of the European Central Bank, Mario Draghi, has finally reversed the policies of his predecessors and pumped hundreds of billions of Euros into money markets to lower the cost of sovereign borrowing and stop the run on the government bonds of Europe’s weaker economies. Draghi has been urged to follow this course by Fed Chair Bernanke and Treasury Secretary Timothy Geithner, and the Fed’s liberal money policy makes Draghi’s task easier because it removes constraints of a dollar shortage in Europe.

The move suggests that the Fed has learned one of the two key lessons of monetary policy from the Great Depression, though it has yet to learn the other. The first lesson was to intervene massively when the economy faces deflationary pressures, to make money as cheap and plentiful as possible. By definition, when the economy is in a severe slump and banks aren’t lending and business isn’t borrowing, inflation is the last thing to worry about.

But the second lesson is to couple loose money with tight regulation, so that low interest rates don’t invite all manner of speculation as they did in the creation of the bubble and the run-up to the crash. The current Fed is better than the Greenspan Fed, and it includes at least two Obama-appointed governors—Daniel Tarullo and Sarah Bloom Raskin who’d like to see tighter regulation of banks and shadow banks.  Richard Cordray, the new head of the Consumer Financial Protection Bureau, is also lodged at the Fed, though the best thing about that location is that he’s independent of the rest of the Fed.  As financial industry lobbying chips away at the regulations that implement the Dodd-Frank Act, the Federal Reserve needs to use its prestige to be the counter-lobby for the toughest possible regulations against speculative abuse.

We’re a long way from that, but a public commitment to very low interest rates for as long as it takes to help cure this recession is a start.

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