By Bluford Putnam, chief economist, CME Group

What would change the mind of the members of the Fed’s Federal Open Market Committee (FOMC) to move forward a decision to abandon the near-zero short-term rate policy?

The answer comes not from data forecasts of higher potential inflation or more jobs growth and lower unemployment rates, although these are certainly possible catalysts that could change FOMC thinking.

As we read the tea leaves of Fed-speak and analyse the emerging culture of the Yellen-Fed, we are struck by a growing desire to get back to traditional policy-making and to leave well behind the emergency policies of the Bernanke-Fed and the legacy of the financial panic of 2008.

There is little doubt that emergency policies were needed in the 90 days following the badly managed bankruptcy of Lehman Brothers and very messy bailout of AIG in September 2008.

And, once QE ends in October 2014, as seems likely, then the next decision point for the Fed is whether to return to a more traditional version of short-term rate policy.  Indeed, we would argue that negative real short-term rates – that is, short-term rates that remain below the prevailing rate of inflation for a sustained period of time – represent an emergency policy, just like QE, that is increasingly being perceived as inappropriate for a growing economy.

A more traditional, non-emergency approach, yet still accommodative for the economy, would be for the central bank to encourage short-term rates to be more or less equal to the prevailing rate of core inflation.

There is another way to look at the debate inside the Fed and why it seems to be shifting.  The policy discussion is no longer just about whether headline unemployment data hide some residual slack in labour markets, as Yellen suggests, or whether rising food inflation eventually will filter into core inflation.

What is coming under more and more scrutiny is whether the Fed, or any central bank for that matter, should be treating an economy as fragile and ready to collapse, when it has run-off essentially five years of modest economic growth since the recovery started in Q3 2009.

Under this logic, QE had to end as soon as possible, and the Yellen Fed is achieving that. The follow-on policy step, is that monetary policy may still remain relatively accommodative but it should not do so any more with negative real short-term rates – a clearly emergency-type policy measure.

As the voices for a return to traditional policy-making (based on the fundamental perspective that the U.S. economy is neither fragile nor ready to collapse) take greater hold on the psychology of more regional Fed Presidents and Fed board members, then the Yellen Fed could easily choose to start the slow process of encouraging incrementally higher short-term rates at either the January or March 2015 FOMC meeting.

The objective might be just to get short-rates up to the level of core inflation by year-end 2015.  Moreover, such a policy shift could easily be reconciled with Yellen’s view that there is still some residual labour market slack, since even if short-rates were roughly the same as the core inflation rate, such a monetary policy would still be characterised as accommodative, just not an emergency accommodative policy.

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