The chairwoman of the Federal Reserve, Janet Yellen, delivered her semi-annual monetary policy report to Congress this week, displaying her usual command of the theoretical reasoning behind the Fed’s ultra-low interest policies. Critics in the Senate and House were mostly flummoxed by her intellectual composure and deft rejection of any rules-based approach, while market investors happily surmised they still had time to keep racking up capital gains on their portfolios.

But the muted rhetorical fireworks on Capitol Hill belie the fact that an incendiary debate is taking place as to whether current monetary policy is stimulating real growth or setting the stage for another financial meltdown. The Bank for International Settlements, a central bankers’ forum based in Switzerland, issued a no-holds-barred assessment two weeks ago warning that near-zero interest rates may be fueling asset bubbles while diverting funds away from productive long-term investment.

Which raises the question: What if Ms. Yellen is wrong? What if her policies are not spurring healthy private sector growth but rather steering flighty low-cost capital into speculative investments? What if her prescriptions are actually deterring commercial banks from carrying out their essential role as intermediaries in providing needed financial resources to worthy borrowers? The Fed’s efforts to engineer a recovery by suppressing interest rates may be inflicting permanent damage on the capacity of the United States to forge its own dynamic path to renewal.

The presumed logic of using easy money to reduce unemployment was tentatively probed by a few brave questioners during the hearings. If firms are borrowing to expand operations—hiring more employees to boost production—why did U.S. productive output, as measured by gross domestic product, fall by 2.9% in this year’s first quarter? Ms. Yellen dismissed the negative number as “transitory” yet maintained that “accommodative monetary policy” was still needed to support economic expansion.

Turns out, though, many of America’s largest corporations have been using low-cost money not to increase their workforce but to buy back their own stock in equity markets. According to a study released in late June by the chief market strategist at brokerage firm LPL Financial, Jeffrey Kleintop, companies purchasing their own shares are the single biggest category of stock buyers. Not only can companies use buybacks to raise their share price, they can also push up the earnings-per-share number (even if earnings are flat) by reducing the amount of outstanding shares.

Such window dressing adds no real value to the economy. But it does explain why inflation, as measured by the Consumer Price Index, has been relatively subdued. If the increased liquidity provided by the Fed is not filtering beyond boardroom valuation strategies, there is no kick to consumer demand.

What’s odd is that some advocates of monetary stimulus hail the lack of inflation as a triumph for the Fed’s policies. But after so much pumping, the lack of a dramatic rise in the CPI is not grounds for crowing: It’s proof that the Fed’s policies are not working. Cheap money is not benefiting workers, not increasing consumer demand—and thus not raising prices for goods and services. Inflation is the dog that’s not barking.

All of which represents a serious challenge to Ms. Yellen’s thinking and future policy decisions. Even if market-determined interest rates would be better for the real economy than the Fed’s continued discretionary interventions, there are other considerations. The biggest beneficiary of near-zero interest rates is the U.S. government, with its $17.6 trillion in debt. The Fed can hardly ignore the impact on the federal budget in deciding whether to continue suppressing interest rates, even though it raises a disturbing conflict of interest to have a government agency determine the Treasury’s cost of borrowing.

And there’s also a troubling assuredness in Ms. Yellen's eagerness to enhance the supervisory powers of the Fed to oversee the financial sector. Speaking before the International Monetary Fund on July 2, Ms. Yellen explained that “macro-prudential policies”—meaning the Fed’s ability to influence banks’ lending decisions through higher capital requirements and new credit rules—would be the Fed’s “main line of defense” in achieving financial stability.

Given the sluggish performance of our economy in the wake of unprecedented stimulus, both fiscal and monetary, does it make sense to give the government a greater role in deciding where capital should flow? Regulators are apt to smile approvingly at banks’ Treasury holdings and credit lines for listed companies, while arching an eyebrow at loans to small businesses and individual borrowers. These incentives are perilously skewed; economic growth depends on getting financial capital to job-creating small enterprises.

Yet with excess reserves having bloated to $2.6 trillion, it’s clear that commercial banks already see the advantage of playing it safe. Warehousing loanable funds at the regional Fed versus lending them out to businesses and households allows banks to avoid regulatory scrutiny—plus, since 2008, they get paid on them. Expect this trend to accelerate.

At the Fed’s policy meeting in June, policymakers showed keen interest in maintaining higher levels of sterile reserves in the future by raising the rate—which means the Fed is prepared to pay considerable amounts of interest to commercial banks to discourage them from making private sector loans.

Meantime, Ms. Yellen provided little clarity this week regarding the alarming disconnect between effervescent stock markets around the world and the disappointing pace of real economic growth. Aside from noting that low interest rates may prompt some investors to “reach for yield” through riskier investments, we are left with Ms. Yellen’s observation from her IMF speech that the effects of monetary policy on global financial stability “are not well understood.”

Now she tells us.