Wheeler asks the questions: will Yellen answer?

If the Fed's Jackson Hole conference is the main course of the monetary policy week, RBNZ governor Graham Wheeler cooked up a tasty appetizer yesterday with his speech on "Monetary Policy Challenges in Turbulent Times."  The speech offers a useful summary of the state of play of modern central banking, and while the decline in the neutral rate of interest is acknowledged and addressed, the fetishization of R* that has characterized the US policy discussion is notably absent.

Instead, Wheeler draws several important points, acknowledging the limits of policy efficacy more explicitly than many of his peers:

* "Expectations of what monetary policy can achieve often run ahead of reality"

*  "Low inflation in some countries is linked to demographic change, especially in countries with a declining workforce and rapidly ageing population. Low inflation is also due to technological change around information flows and energy production, and to the global over-supply of commodities and manufactured goods"

* "Central banks only have limited control over tradables inflation. For example, they have no influence on the global oversupply of commodities, manufactured goods and capital goods, or on overseas inflation rates"

*  "The decline in neutral real interest rates may be linked to the slowdown in productivity growth, and the growth in global savings linked to post-GFC deleveraging and aging populations"

*  "In responding to this economic setting, monetary policies are being stretched well beyond the normal parameters and stresses envisaged when policy frameworks were designed and inflation goals were first specified" 

He also raises a number of key questions that policymakers are confronting, which perhaps offers a guidepost to the sorts of topics that Yellen might cover on Friday:
  
* what are the risks that global growth will be revised lower? What is the outlook for commodity prices, and especially oil prices? How can the advanced economies achieve the growth rate needed to generate the ‘escape velocity’ to ensure a durable recovery and moderate inflationary pressure?; 

*  how long are the major central banks likely to run a divergent monetary policy stance (although they have become more similar as the Federal Reserve has pushed back expectations of interest rate rises)? When might the Federal Reserve next raise the Fed Funds rate?; 

* has monetary policy reached the limits of its effectiveness in central banks with negative policy rates and large programmes of quantitative easing? How much scope is there for additional monetary accommodation and will this be deployed - especially by large central banks, such as the European Central Bank and Bank of Japan?; 

* how serious are the distortions created by negative interest rates, and by quantitative easing and the associated rapid expansion of central bank balance sheets? How can these balance sheets be deleveraged over time and excess bank reserves absorbed, and what does this imply for monetary policy, asset prices and global long term interest rates?; 

* what are the risks that inflation expectations will fall further? How can inflation expectations best be raised when policy rates are already low, household indebtedness is high and households and firms are reluctant to borrow more?; 

* how reliable are the central bank’s estimates of the output gap? How flat has the Phillips Curve become and how much has the neutral interest rate fallen?; and 

* how should fiscal policy support monetary policy?

In the meantime, we are left with remarkable flat money market curves throughout the world, including the US.  EDZ6/EDZ8 currently trades at just 27 bps; while there is of course the impact of the money fund-related boost to LIBOR impacting the front leg, that's still remarkably flat (and perhaps worth a flutter?)

Even more notable is the flattening further out the curve.   The 5th vs 13th contract spread is just 25 bps, the lowest it's been since before the crisis (when Fed funds were 5.25%, not just north of zero.)

Contrary to the belief in some quarters, central banks are not omnipotent, as Wheeler suggests.  The sooner that certain members of that fraternity embrace that fact, in all probability the better off we will all be.