On the transient necessity of central bank independence Nowadays, the idea of not having an independent central bank is seen as being a bit backward. One could even say that central bank independence is widely accepted as the optimum set-up for any country's monetary system, a reflection of its developmental status. Independent central bank? Check. This country must be civilised.  Yet, can we really be so absolute about the matter? In Raiders of the QE surplus - a post that challenged the controversy regarding the UK Treasury's so-called raid of Bank of England surpluses - David and myself proposed that central bank independence must not be treated so resolutely. We argued, in fact, that any central bank's status should be determined by the economic context it finds itself in. After all, it's impossible to separate the notion that, however you look at it, a central bank is always an agent of the Treasury. The two are in effect a married couple. Or as we put it, regarding independence: ...it's just another type of Chinese wall - and whichever way you look at it, the BoE and the HMT will always be a married couple, just one whose professions vary and conflict on occasion to varying degrees. Accordingly, if ever there was a time to change our attitude on central bank independence, the time may be now - a point well reflected by the current debate over whether the minting of a $1 trillion platinum coin would be a reasonable - or at least, suitably absurd - way to fend off a debt ceiling impasse. Indeed, if ever the boundaries between a central bank and the Treasury were being blurred it's now. And while this line of thinking has always been the Modern Monetary Theory (MMT) school's argument, even the likes of Paul Krugman are getting in on the argument. As he noted in response to criticism that money printing doesn't matter in a liquidity trap: As best I can tell, what set the ragers off was the suggestion that under current conditions - that is, in a liquidity trap - it really doesn't matter whether the government covers its deficit by selling debt or just printing money, which is why, among other things, using the platinum coin ploy to sidestep the debt ceiling would be harmless. The MMTers showed up, as usual, to insist that debt versus money printing *never* makes a difference; but that's a different story. But if you're looking for more than just conjecture on the matter, the latest paper from Paul McCulley and Zoltan Pozsar at the Global Society of Fellows is undoubtedly worth a read. As they note: The ultimate message of our paper is that while central banks may fear fiscal dominance, they will not be able to avoid it. Fiscal dominance and central bank independence come in secular cycles and mirror secular private leveraging and deleveraging cycles, respectively. That is, as long as there will be secular debt cycles, central bank independence will be a station, not a final destination. This paper builds on our earlier work that provided an historical overview of episodes when orthodoxies came in conflict with democracy and were overruled by politics (see McCulley and Pozsar, 2012). In our present work, we transition from using history as guidance to identify the optimal policy mix du jour and focus instead on explaining the economic logic of why orthodoxies will continue to be discarded in the advanced world and why the democratic process will ultimately "corner" policymakers into fiscal-monetary cooperation. In other words the economic context is vital. As McCulley and Pozsar go on to argue, when any economy finds itself the midst of a secular private deleveraging cycle, it's time to reconsider monetary orthodoxies such as central bank independence. fiscal orthodoxies of austerity and balanced budgets remain entrenched and risk chaining the advanced world into a state of large output gap torpor or worse. Of course, there are caveats. Very much like the MMTers, McCulley and Pozsar stress that this line of thinking only applies to economies that issue their debt in their own currencies, have monetary sovereignty (ability to monetise debt) and enjoy the luxury of a relatively stable demand for their debt instruments from global investors. This line of thinking cannot be applied to small, open economies who operate under some form of currency peg that precludes it from printing at will, the Eurozone countries being the clearest example of that. Once these rules are understood, the authors offer up the following Global Macro Chessboard to help navigate through an economy's needs at any particular time: To the above you apply the following: Confused? Don't worry. You're supposed to be. Also we think it's better to think of the above as a snakes and ladders board than a chessboard. But essentially this is how it works: First, asses the private sector's general mood and attitude to debt. The left represents leveraging mode, when the private sector is in borrowing and non-saving mood. The right represents the opposite: deleveraging mode. Now, say the authors, understand that the key drivers of secular debt cycles are asset prices - which in themselves are driven by animal spirits and interest rates. Now, appreciate that the switch from one mode to the other is mainly "binary" and triggered by a collapse in the price of assets that underpin loans. The inflection point can be considered the Minsky Moment. Now, appreciate that policymakers are wrong to consider that the private sector is always in secular leveraging mode. And now - most importantly - appreciate that when the private sector flips to deleveraging mode, everything is turned on its head. As the authors state: black becomes white and unorthodox becomes orthodox. Ultimately, the chart stresses the following: Monetary policy gets easier as we go right along the (x) axis. Fiscal policy gets easier as we go up along the (y) axis. Meanwhile: The relationship between the fiscal and monetary authority is dynamic over time. In the case of the Federal Reserve and Treasury one observes a relationship that is heavily circumstance-dependent. Each passage from one quadrant to the next is not easy, say the authors. Also, it's usually associated with either democratic or technocratic processes. They cite the interwar gold standard as an example of a democratic process that saw the economy pass from the depressionary blue quadrant back to the yellow. Indeed here's a nice example of previous quadrant transitions: The authors end by channeling Ben Bernanke's observations about Japan in 2003: [I]t is important to recognize that the role of an independent central bank is different in inflationary and deflationary environments. In the face of inflation, which is often associated with excessive monetization of government debt, the virtue of an independent central bank is its ability to say "no" to the government. [In private deleveraging cycles], however, excessive money creation is unlikely to be the problem, and a more cooperative stance on the part of the central bank may be called for. Under [such circumstances], greater cooperation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than cooperation between two independent nations in pursuit of a common objective [or for that matter, cooperation between central banks and fiscal authorities to finance war] is inconsistent with the principle of national sovereignty. Now if we could only get the political class to understand that "it's the context, stupid." Related links: Helicopter Money: Or How I Stopped Worrying and Love Fiscal-Monetary Cooperation - GSF On the new purpose of government debt - FT Alphaville When stimulus becomes stealth nationalisation - FT Alphaville The liquidity trap heralds fundamental change - Coppola Comment