Alan Greenspan's likely reappointment as Fed chairman must trigger a long-overdue examination of monetary policy, especially during the Greenspan reign.

Contrary to widespread belief, monetary policy does not consist of Fed control of the money supply. Instead, the Fed passively supplies whatever amount of currency the public wants to hold and the reserves that banks need to meet their reserve requirements.

Any attempt by the Fed to control the money supply would negate what it really does, which is to signal to the financial markets what it believes is the appropriate level of short-term interest rates. A government agency cannot control both the quantity and price of any good or service; the Fed tries only to do the latter.

However, the Fed cannot directly move interest rates, because its open market operations occur in the federal funds market, a tiny, artificial marketplace by comparison with the total market for short-term debt securities. The Fed's domain is comparable to a child's sandbox stuck in one corner of a football field.

Consequently, the Fed cannot move interest rates through brute force, the buying or selling of Treasury securities. Its influence over rates stems strictly from the perception that it can move rates, much as the Wizard of Oz's influence over the Munchkins grew from their belief in his power. Toto, though, revealed the truth.

On Feb. 4, 1994, the Fed stopped using open market operations to signal its desires. Since then, it has merely announced a fed funds rate target after meetings of its policymaking Federal Open Market Committee. The financial markets are then supposed to fall dutifully in line, at least at the short end of the yield curve.

FOMC rate announcements, however, constitute industrial policy. The unspoken conceit underlying this marketplace intervention is that the federal government can do a more responsible job of pricing credit than the financial markets.

That notion, of course, is absurd.

In reality, the central tendency of competitive financial markets is to set interest rates that will produce noninflationary credit growth because economies operate most efficiently when prices are stable. Given the financial markets' growing dominance in setting interest rates, inflation is declining steadily throughout the industrialized world.

As long as the Fed passively supplies currency and bank reserves, the money supply will be totally demand-driven and, thus, won't cause inflation. Hence, the money supply, which is merely those forms of credit that facilitate transactions, is no longer a public policy concern.

FOMC rate announcements, though, are a concern because the Fed's bureaucratic sluggishness lacks the nimbleness of the financial markets. Consequently, the Fed's rate signaling magnifies interest rate swings, which unnecessarily whipsaw the economy.

Recently released FOMC transcripts report that in 1990, Mr. Greenspan missed the onset of the last recession, aggravating that downturn. The Fed was late again in early 1994, when it sanctioned a rise in short-term rates. This delay intensified the damage caused by bursting bond and stock market bubbles. Many analysts now believe the Fed has been far too slow in reversing its 1994-95 interest rate overshoot.

In light of present-day monetary realities, the Fed's relevance and Mr. Greenspan's role as Fed chairman must be carefully examined.

In particular, Mr. Greenspan's much-praised obfuscations must be seen as a sophisticated yet intellectually dishonest masking of the fact that there is much less to the Fed than most believe. Mr. Greenspan is a very talented Wizard, but does America need a wizard in a world of increasingly competitive financial markets?

Also, Mr. Greenspan is immodestly silent when undeserved praise is heaped on the Fed.

For example, some claim that the steep yield curve the Fed engineered in the early 1990s saved commercial banks; however, banks' increased interest margins in those years occurred for other reasons.

The yield curve, though, fueled unhealthy bond and stock market speculation that blew up when rates jumped in 1994.

A fundamental examination of monetary policy might wake up the munchkins of the financial markets to the fact that they, not the Fed, control all interest rates. The markets might then begin to ignore the Fed's rate signals, which in turn would produce less interest rate volatility and therefore more stable economic growth.

This examination also should lead Congress to tackle the real causes of inflation today, which are rooted in government distortions of interest rates. The home mortgage interest deduction, government loan guarantees, and mispriced deposit insurance are examples.

While the financial markets have become increasingly adept at neutralizing these distortions (but with the consequence of misallocating capital flows within the economy), eliminating them would reduce inflation more efficiently. The rationale for Fed-administered industrial policy would then cease.

Mr. Ely, the principal in Ely & Co., is a financial institutions consultant in Alexandria, Va.

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