"The central bank can buy assets," said Governor of the Bank of Israel Prof. Stanley Fischer last week in response to a question about the Bank of Israel's options if its monetary policy runs out of ammunition.
Fischer declined to provide specifics, and other senior Bank of Israel officials declined to comment. There is no doubt that the "assets" referred to are government bonds issued by the Ministry of Finance, since it hard to imagine the Bank of Israel buying corporate bonds or shares directly from the market.
The objective of the Bank of Israel, should it decide to buy government bonds, would be to affect the long-term interest rate. Fischer explicitly said that "1% is not zero" in response to a question whether interest rate cuts would continue. The basic interest rate is a short-term rate; interest on government bonds is a long-term rate.
Substantial and continuous purchases of 10-year government bonds by an agency such as the Bank of Israel would significantly boost demand for the financial product, which will raise its price and lower its yield. When a company applies to a bank for a loan, the bank could cite the interest rate on 10-year government bonds as the market price of money for this period.
If the Bank of Israel implements a policy of buying 10-year government bonds, it will indirectly lower the cost of money and increase liquidity in the system by increasing available credit. This is a key Bank of Israel objective in the current credit crunch, which is jeopardizing economic growth.
The Bank of Israel declined to comment on reports about purchases of government bonds. However, a senior bank official told "Globes", "It could happen, but not necessarily right now."
Published by Globes [online], Israel business news - www.globes-online.com - on February 1, 2009
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