Recently Bank of Israel Governor Stanley Fisher became the first Western central banker to raise interest rates. Central Bank rates in most Western nations range from 0.25 to 1 or 2%, after banks drastically slashed rates to battle the global recession. Most of these banks are for now maintaining rates at their low levels.

But could they have reduced rates even further? Is it possible, for instance, to set a negative interest rate? In other words: I borrow $100, and at the end of the year, pay back only $99?

Of course, this has happened in the past, when real interest rates (the nominal or actual rate less inflation) were negative, because inflation exceeded nominal rates. But, can nominal rates be negative?

Writing in the Financial Times, Wolfgang Munchau points out that “the zero lower bound [of interest rates] is one of the great myths of monetary economics”. Last week, he notes, the Swedish Riksbank set a small negative deposit rate. I recalled, in reading his piece, that decades ago the Euroyen interest rate (the rate of interest paid on yen deposits held in European banks) was negative, when Japanese interest rates were about zero, mainly because banks did not want to hold such deposits and set negative rates to discourage them.

Should this be done? Can it? asks Munchau.

The answer to both is, yes. 

We teach managers to examine every single fundamental assumption inherent in their business designs. Governments and central banks should do the same, in these turbulent times. What are we assuming, they should ask, that may be wrong.

Apparently, the assumption that interest rates must be above zero is one of them.