Governor of the Bank of Israel Dr. Karnit Flug has granted an interview to "Banking," a publication of the Association of Banks in Israel. The following are selected quotes from the interview.
The first economic issues the new government will have to handle
Flug: "First of all, the government will have to take care of the budget - both completion of the 2015 budget and looking ahead. It will have to address the fact there is a conflict between many decisions about projects and other decisions with budgetary consequences and the budgetary rule decided by the outgoing government. It remains to be seen how this collection of decisions can be made consistent with the decision about total spending. Beyond the upcoming budget, a mechanism must be found and used for ensuring that this inconsistency is reduced and eliminated, because this is a problem that has accompanied us in budget planning for a long time.
"There is much to be done, but first of all, goals must be defined. A very general goal with which I agree, and about which there is a broad consensus, is the goal of sustainable and all-inclusive growth. The meaning of such a goal is that there is a need to increase all-inclusive growth, i.e. growth that includes different populations and sectors in the economic process, while narrowing gaps and reducing the dimensions of poverty. If that is the goal, government policy must be derived from it."
On monetary policy
"Our monetary policy is aimed at the targets established in the law - both maintaining price stability and supporting growth and employment. Our policy is forward looking, and when we looked ahead, we were disturbed by the fact that since the devaluation that took place between August and December, we saw that it was eroding. When we look at the effective exchange rate (with respect to the basket of the currencies of countries with which Israel trades), we saw that the exchange rate was sinking, among other things because of the very expansive policy pursued in many countries, including negative interest rates and quantitative easing on a large scale. This caused a reversal of the devaluation. This trend worries us, given the business sector's need to cope with a still recessive global climate. That was the reason why the interest rate (for March) was cut, and obviously also because inflation is still very low."
Q: Will you consider quantitative easing measures on the same format used by other countries?
"Looking ahead, the goal is to support continued growth and employment, including in exports and industry. Since the global crisis, we have seen various countries adopt expansive policy measure, even when they reach a negligible interest rate. They will eventually have to take additional steps. The choice of which steps are more suitable will be related to the specific circumstances. We are considering them, and looking at the measures taking in other countries, but the decision about what to do will be made according to the circumstances."
Q: Give us your opinion about the criticism that the Bank of Israel is isolated from the general perspective, especially about the argument that a continued shekel depreciation fuels demand in the housing market.
"The Bank of Israel is not at all isolated from the general perspective. The discussions are very thorough, the decisions are not easy, and the developments in the housing market play a very significant role in the discussions. It is impossible, however, to cope with all the goals solely through the use of monetary policy tools. As I explained, the interest rate cut is aimed at supporting growth and employment. There is no doubt that the interest rate policy also affects demand in the housing market, just as the entire array of interest rates does. Keep in mind that the longer-term interest rates also affect demand, and also that the short-term rates are not isolated from the global interest rates. The yields on various durations of bonds are at a very low level, as a result of the very low global yields, and also of the interest rate policy.
"In the current interest rate climate, if we want to support the goals I spoke about, we can't be at an interest rate that is significantly higher than the global interest rates. When you boil it down, the issue of housing prices has to be dealt with by significantly increasing the supply; there is no other way. Bottlenecks have to be released, and a planning inventory insured. Land must be marketed on an appropriate scale, and building starts have to be in numbers that supply the demand in the market, and in regions that include the high-demand regions. All this assumes that we are in a low interest rate climate. That is the only way to deal with the housing market.
"I don't think that a 0.15% interest rate cut, when the direct effect on mortgages is in any case limited to a third of the mortgages (the largest proportion are at the prime interest rate), is the cause that is driving the housing market. By restricting the part of the mortgage that is linked to the prime rate, we restricted the effect of the short-term interest rate to some extent, while the Bank of Israel interest rate has a more limited effect on the long-term interest rate."
Q: The Bank of Israel has spoken in the past about the need to raise taxes. How do you see this today?
"There are two parts to what we have to say on this question. One part concerns the budgetary rules. In our opinion, the ratio of public debt to GDP should be cut further. If the government adheres to its budget deficit target, the public debt will fall to 60% of GDP by the end of the decade. This is a desirable target when Israel is exposed to shocks. Lower public debt bolsters the economy's resistance to shocks, and we also have a significant burden of interest payments on this debt.
"The government has also adopted a rule for spending that sets the extent of spending over time, and we'll have to consider whether this rule will also accompany us in the future. Assuming that the government increases its spending according to this spending rule, which is a relatively moderate rule providing for 2.6% annual growth in spending, these two fiscal rules adopted by the government are inconsistent if the tax system remains where it is today.
"For this reason, if we adhere to the rule of cutting the budget deficit, and also adopt and adhere to the spending rule, we will have increase tax revenues in 2016. It is worthwhile considering first eliminating exemptions with no economic justification, with raising tax rates as a second choice."
Q: Comment on the cost of living problem.
"The question of the cost of living is complex and multi-dimensional. Comparing particular products in a supermarket in Israel with other countries therefore fails to give the whole picture. Some of the picture consists of looking at the cost of a basket of product and services in Israel in comparison with other countries, taking into account our standard of living, our per capita GDP. When you make this comparison, you see that our basket is slightly more expensive than what you would expect from a basket of products and services in Israel, given per capita GDP in Israel
"The discussion is complicated, and therefore the solutions are also complicated. They include bolstering competition in non-competitive sectors, reducing import taxes, and also solutions that are more related to the question of how to increase the earning capacity and labor productivity, so that wages will rise." p>Published by Globes [online], Israel business news - www.globes-online.com - on March 26, 2015
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