Photo: Bloomberg Television
The idea of central bank independence is one of the most sacred principles in all of finance.However, Paul McCulley thinks it’s time to break this rule. McCulley, a fellow at the Global Interdependence centre and form senior partner at PIMCO, presented his argument today at the Banque de France in a paper titled Does Central Bank Independence Frustrate the Optimal Fiscal-Monetary Policy Mix in a Liquidity Trap?.
“We need to actually rethink the mix between monetary and fiscal policy,” McCulley told Bloomberg’s Mike McKee. “The doctrine of central bank independence, which is truly a religious matter, doesn’t hold at all times.”
Prior to the financial crisis, central banks had the capacity to fine tune the economy every six weeks or so by adjusting interest rates, said McCulley. Central bank independence works “as long as the private sector is elastic to changes in short-term interest rates.”
Lately, however, the private sector hasn’t been as responsive to monetary policy.
“A liquidity trap is when the private sector doesn’t want credit at any price. And the evidence of that is we’ve taken the price to zero and we still have a massive amount of debt problems in the household sector. So once you’ve reached the liquidity trap, the world changes.”
There are certain circumstance where you should have more cooperation between fiscal and monetary authorities. Now is one of those times, argues McCulley.
Here’s McCulley’s interview with Bloomberg’s Mike Mckee: