By Sheila Bair and Preston Cooper
January 29, 2014

FORTUNE — When the Fed meets to decide its monetary policy on Wednesday, Jan. 29, we believe it should continue tapering its bond buying program and let interest rates rise. Why? Low interest rates and low inflation are having a negative impact on the vast majority of American families.

Those who argue for an aggressive monetary policy believe that the economy is still weak and needs to be juiced up. And why not as long as the economy remains below the Fed’s inflation target of 2%? By the Fed’s logic, an inflation target above 2% will help make sure the economy does not fall into deflation nor suffer from inflation.

Yes, accommodative monetary policy poses longer term inflationary risks, the quantitative camp argues, but it also produces near-term benefits to economic growth and job creation by making it cheap for households and businesses to borrow, which in turn will lead to increased consumption and business investment. Conversely, a more restrictive monetary policy will have a dampening impact on prices, with higher interest rates making it more expensive to borrow, thus reducing credit-driven demand.

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Yet, our experience over the past five years of extraordinary monetary accommodation challenges this conventional wisdom.

Notwithstanding $4 trillion of bond purchases, Main Street families have suffered substantial wage deflation. Improvements in the unemployment rate have been achieved primarily through people dropping out of the workforce because of age or frustration, not because new business investment is creating jobs.

As was the case prior to the 2008 subprime crisis, the risks of low interest rates can be seen not in consumer price inflation, but rather asset inflation. Prior to 2008, it was housing prices. Today, it is financial assets. This is wonderful news for the wealthiest segment of America, which owns the overwhelming majority of stock. But as we learned in 2008, asset price appreciation driven by the availability of cheap credit is not sustainable. Eventually, it will collapse.

The Fed continues to myopically look to the unemployment rate and “core” inflation (which excludes food and energy-huge components of any household budget) in making decisions on further quantitative easing and continuation of near-zero interest rate policies. Instead, they should be looking at the real-world impact of their policies on wage-earning families.

As you can see from the graph below, during the early and mid-2000’s, household income roughly kept pace with the Consumer Price Index (CPI), a broad measure of inflation. After the recession hit in 2008, however, a gap opened up between income and prices. Real household income, adjusted for inflation, has therefore declined since the recession.

The CPI inflation rate was approximately 1.5% in 2013, while core inflation was 1.7% — just below the Fed’s target. However, looking at consumer price inflation alone doesn’t truly capture the effect of price increases on American families. Instead of just looking at inflation, the Fed should consider the gap between income and inflation. And the gap is wide.

In 2012, nominal median income was only 1.7% higher than it was before the crisis, in 2007. (The Census Bureau has not yet released data for 2013.) Meanwhile, prices in 2012 had risen 8.5% from their pre-crisis peaks, for a spread of 6.8 percentage points. Therefore, the purchasing power of the average American family is still significantly below what it was before the crisis.

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Moreover, a large proportion of Americans remain unemployed or underemployed. The Bureau of Labor Statistics’ U-6 unemployment rate, which takes into account those who have been out of the labor force for a short time, as well as those who work part-time when they want to work full-time, stood at a whopping 13.1% last month.

It’s likely that many of these discouraged workers are living off their savings, which even low inflation is gradually eroding. These families do not have access to the red-hot stock market. Their money is in bank savings accounts which yield substantially less than the 1.5% inflation rate.

Given the unique circumstances of this still-sluggish recovery, the Fed should seriously consider revising its inflation target downward to 1% or even lower. That means tapering the third round of quantitative easing and allowing interest rates to slowly rise.

The monetary economist Milton Friedman once said that “inflation is taxation without legislation.” Unfortunately, that quote is far too close to reality for the many Americans still hurting in this recovery.

Fortune contributor Sheila Bair is the former chief of the FDIC and was recently appointed to the board of Banco Santander. Her son, Preston Cooper, is a financial journalist and economics major at Swarthmore.

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