Until now, and for the past two decades, at least, the headlines generated by monetary discussions at the Bank of Israel usually involved the level of interest rates. However, Governor of the Bank of Israel Prof. Stanley Fischer arrived today for a wide-ranging meeting about monetary policy in a similar situation to that in which his colleague and student, Federal Reserve Board Chairman Ben Bernanke, found himself Wednesday: He cannot lower the interest rate by much, he cannot raise it, and he has to do something big, as the crisis is worsening, economic output is falling, and the number of unemployed is rising.
Among senior economists in Israel, the only real disagreement can be summed up simply: Will Fischer cut the interest rate by 0.25% or will he leave it unchanged. That is the extent of the room to maneuver that Fischer has left regarding the conventional tools (interest rates).
In any case, Bank of Israel officials have already realized that even if Fischer cuts the interest rate again, by 25 basis points, to 0.5%, the move won't be effective at all.
That is the reason that at the Bank of Israel, they believe that Fischer's announcement tomorrow will be very similar to that of Bernanke: Something small about the interest rate either a 25 basis point cut or no change and in addition, something grandiose.
Fischer has already announced buying government debt, and is not ready yet to announce buying corporate debt, so the chances are increasing that he will wait no longer and announce the beginning of "quantitative easing". Expectations of this move receive credibility from the minutes of the two most recent monetary discussions at the Bank of Israel. In both discussions, Bank of Israel officials say that when interest rates are at historic lows, the bank will focus on utilizing other instruments, and immediately afterward the term "quantitative easing" shows up.
What is quantitative easing?
So what exactly is quantitative easing? Each time the Bank of Israel lowers the interest rate, it does so by increasing the supply of money. At a time like this, there is no possibility to cut interest rates further. At the same time, the central bank can continue to increase the money supply through buying financial instruments, such as government bonds, on the open market. The central bank buys the bonds, which it lists on its balance sheet, and in return it prints money and sends it into the market. The Bank of Israel has begun already to act in the government bond market, intending to influence longer term interest rates. But at the same time, it is instituting sterilization moves. That is, the bank is putting money into the market in return for the bonds, but it immediately issues Treasury bills which absorb the money which it put into the market, and takes that money out of the market.
Currently, Fischer is doing two things which lead to full or partial sterilization: purchasing $100 million on a daily basis as well as NIS 31 million in bonds. Fischer's intention is to stop and significantly reduce sterilization activities and increase the amount of money without any connection to basic interest. One of the main differences between lowering interest and quantitative easing of money is that the second measure involves changing the central bank's asset balance. One of the essential questions raised by the planned quantitative easing is if Fischer can buy corporate bonds or assets that might be risky, in the same way that Bernanke did last week.
When the Bank of Israel purchases $100 million, it prints NIS 405 million and records $100 million on its balance sheet, undoubtedly a safe asset. In contrast when the Bank of Israel acquires high-risk corporate bonds, it raises the money required according to the market price and record on its balance sheet an amount that can fall to zero, if that particular company collapses. Therefore, quantitative easing has another name, credit easing, where the central bank in effect gives loans directly to the business sector while taking the risk on itself, a role usually belonging to the commercial banks rather than the central bank.
Fischer's thinking is focused on new and non-conventional measures and will hint at the Bank of Israel's future monetary policy.
Published by Globes [online], Israel business news - www.globes-online.com - on March 22, 2009
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