When interest rates fall towards zero, it is argued, monetary policy becomes ineffective, since it enters a “liquidity trap” where it can no longer stimulate demand. In these conditions, fiscal policy is needed to stabilise inflation. For as long as interest rates remain constrained by the lower bound, the argument goes, monetary policy should therefore support fiscal policy to achieve price stability.
But central bank independence, it is said, impedes such coordination. To begin with, the notion that monetary policy is ineffective when the lower bound is reached has been disproved by the experience of the crisis.