As central banks frantically seek ways to battle the deepening global recession, we are seeing innovative ideas in the most unlikely and conservative places.

United States Federal Reserve Chair Ben Bernanke is boldly pioneering a rather new idea in central banking, known as ZIRP – zero interest rate policy. He has set the Fed overnight rates at a band of between zero and 0.25%. Yes, if you are a bank and need short-term money (overnight or for a weekend, say, to meet a payroll), you can borrow from the Fed at essentially zero interest. It is expected that as the United Kingdom recession deepens, Bank of England Governor Mervyn King will also slash rates to zero or near-zero. And Europe is likely to follow suit, as virtually every major European economy sinks into recession.

“Desperation is the mother of innovation,” goes one version of a well-known cliché. Many nations are now desperate, seeking to battle rising unemployment and recession with monetary and fiscal tools. With interest rates at or close to zero, it is now incumbent on fiscal policy – government spending and taxation – to do the job. President-elect Barack Obama has announced, even before he takes office on Jan. 20, a fiscal stimulus package amounting to some $850 b., including infrastructure spending and middle-class tax cuts. 

I hate to be a doomsayer, but – Japan tried zero interest rates for years, after its property bubble burst in 1990. It did not work. The Japanese government and Central Bank pushed cheap money into the system, but people, spooked by huge debts and uncertainty, chose not to borrow. The ones who did borrow were foreigners, who pursued what is now known as the ‘carry trade’ – they borrowed yen, sold the yen, bought dollars and lent the money or invested it in high-yield markets (like Russia). This did not help Japan in the least. 

Look for normally cautious Central Banks to innovate even more radically in future. It has at last occurred to Central Bankers, that this crisis is different from previous ones, and it will take creative thinking to battle it.