Bank of Israel Governor Prof. Stanley Fischer is probably the first central bank head outside of the Far East to herald the end of the recession and renewed growth. That is the full half of the cup in yesterday's Bank of Israel announcement to raise the interest rate by 25 basis points to 1%.
The essence of the announcement is simple: demand in the economy is expanding, there is a certain rise in demand for new workers, the budget deficit will be lower than expected and there are resurgent rises in share prices in the capital market. In the world market too there are signs of recovery, which will continue to support renewed growth in Israel. If all these elements are put together, then the situation is right for a return to a more traditional monetary policy, which will strive first and foremost, for price stability.
In effect, Fischer is working to prevent rising demand from disturbing his attempts to lower inflation and achieving annual inflation of 2%, which is the government's target. In other words, not only is Fischer persuaded that the conditions are ripe for implementing an additional step in a renewed monetary policy, he also thinks that it is necessary to prevent a rise in inflationary pressure in the coming months. If the Governor wanted to send the message that he has returned to "business as usual" in all matters relating to his anti-inflationary positions, then that was achieved by his unexpected interest rate hike.
Fischer's latest action must be judged from the standpoint of the global economy. In recent weeks there have been intensive and tense negotiations between China and other countries in East Asia, and the US and Europe on what is being called "a new balance in the global economy."
According to the US scenario, countries with balance of payments surpluses will work towards reducing them, through measures to increase local consumption. In contrast the US will reduce consumption and increase savings to reduce its balance of payments deficit. The process will be reflected, first of all, in an appreciation of the currencies of those countries with a current account surplus, mainly China.
Israel is a small economy and outside of these considerations of a new world balance, or at least so the Bank of Israel claims. However, an interest rate hike works in this direction. Fischer sees local consumption rising, and pushing growth, and so defending exports has become less urgent than before. At the end of the day the shekel will strengthen against most currencies, and that won't bring about a renewal of the recession. Exports remain a central consideration in Israeli economic policy but it is a less important factor in the Bank of Israel's decisions than it was several months ago.
There is also an additional global element to Fischer's interest rate hike. It is no secret that there are central banks in the world, especially in Europe, that desire making there change in direction in monetary policy. The European Central Bank would very much like to do so but is committed to coordinate matters with the US and other countries as part of an agreement reached at the G-20 summit in the US in September. The leaders decided that it is up to the various countries to continue their expansionary policies until it is clear that the recessionary dangers have passed.
Fischer is exempt from these considerations because of the tiny size of the Israeli economy, and the fact that Israel is not part of the G-20, which is made up of only large economies. In fact there are no global repercussions from Fischer's interest rate hike, and its influence is limited to the Israeli economy, and he can allow himself to implement restraining policies without taking into account other countries.
That is the simple explanation for the Bank of Israel's decision. But there is also an additional explanation in which Fischer is simply ahead of other economies, and is blazing a new trail that others will follow in a while. The Bank of Israel Governor has not hidden in recent months his opinion that countries must abandon their expansionary policies if economic conditions obligate and enable them to do so. His latest step is a type of call to all to move in this direction, and a sign to the world that talking about a continuation of expansionary policies for a long period is not accepted by everybody.
Published by Globes [online], Israel business news - www.globes-online.com - on November 24, 2009
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