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.
read the tea leaves of Fed-speak and analyse
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
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.
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
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.
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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