Far from Chicago

Adrian Filut

Leo Leiderman understands that extraordinary times call for unconventional methods, but his basic conservatism remians.

Unless some skeleton is discovered in Prof. Leo Leiderman's cupboard, the senior appointments committee headed by Judge Jacob Turkel will approve his appointment as Governor of the Bank of Israel. One of the most important questions that arise the day after the prime minister and the minister of finance announced their choice is: How will Leiderman's monetary policy look? What will be different in comparison with the policy of his predecessor, Stanley Fischer? How will the new governor deal with the burning issues of the day? And, in general, what is the economic outlook of the man who is expected to turn quickly into a leading figure in the economy?

1. View of the job

Leiderman's outlook has changed dramatically since the great crisis of 2008. He understood that steps were required that were "outside the box", and that what he learned in Chicago had been rendered obsolete. He no longer believes as he once did that a central bank should deal exclusively with inflation, without any intervention whatsoever in the foreign exchange market, and completely ignoring what happens in the assets markets, including the real estate and capital markets. He identifies closely with the aims of the governor as set out in the new Bank of Israel Law, including the order in which they were formulated: first, price stability and restraining inflation, and after that, to the extent that the inflation level permits, supporting growth and employment.

The third aim, which for an experienced financier like Leiderman will be no less important than encouraging growth, is maintaining the stability of the financial system. A further point: Leiderman believes strongly that the governor must attribute huge importance to his other role, that of economic adviser to the government, and he can be expected to be very active in that respect.

2. Economic outlook

The emphasis in economic policy is how to make the cake bigger, and much less how to divide it up; how to create more jobs, with an emphasis on expanding investment in the economy and Israel's export markets (including the emerging markets in which Leiderman is an expert).

Leiderman is also sensitive to social issues. A prominent example of that is his opposition to raising VAT, which he described as "a completely unreasonable step" since it was a matter of "a regressive tax that hurts the middle class and weaker sections of the population". Nevertheless, Leiderman is no Trajtenberg. He makes no sidelong glances at socialism, neither in its modern nor in its classic forms. He is a thoroughgoing right-wing economist, the strongest evidence of which is that both Netanyahu and Lapid, two out-and-out anti-socialists, chose him.

3. Monetary policy

In a small, open economy, in which capital movement is free and interest rate data is transparent to everyone, Leiderman believes that a phenomenon has arisen, especially after the crisis, that he calls "globalization of monetary policy". He can therefore be expected to keep policy in Israel in line with policy overseas, particularly the US and Europe, and international interest rate developments will be a dominant factor in his interest rate decisions.

in his view, interest rate policy has changed in a positive but unpredictable direction, just as the crisis was unpredictable, and he will presumably continue the line of outside-the-box policy. It is important to remember however that Leiderman sees a negative real interest rate (the interest rate after discounting inflation or inflation expectations) as a problem, since it can create asset bubbles, such as real estate bubbles. He is therefore more sensitive to this point.

4. Exchange rate policy

Leiderman was one of the first to express opposition to the Bank of Israel's foreign currency buying policy, in early March 2008. We should remember that he and Jacob Frenkel initiated the end of intervention in the foreign exchange market, but in recent years he has corrected himself, and publicly acknowledged that when the interest rate against the US dollar reaches 3.3 shekels and this cannot be explained by economic fundamentals, there needs to be intervention in the foreign exchange market. Nevertheless, he can be expected to be more conservative than Fischer here, and, as far as he is concerned, as long as the foreign exchange market runs reasonably, with enough trading and liquidity (even in cases of sharp appreciation of the shekel), there is no need to intervene.

After following foreign exchange trading for years, Leiderman surely knows how marginal the Bank of Israel's influence over the dollar-shekel rate is. We can assume that an interest rate cut such as we saw two months ago, explained almost entirely by "a low exchange rate", is unacceptable to his world view.

5. Fiscal policy

Economists don't like big deficits. Economists from Chicago really abhor them. This stems from a belief that large, prolonged deficits expand debt, and endanger real economic activity that contributes to growth and employment.

Leiderman will not tolerate large deviations from the deficit guidelines set for the next two years. Between the alternatives of budget cuts and higher taxes, he will choose lower expenditure and avoidance of raising tax rates. In this connection, he will attempt to do away with the various formulae that determine a fixed amount of real growth in the budget. Nevertheless, as a pragmatic and conservative man, he will not press for quick or drastic changes that will upset the economy's equilibrium.

6. The financial system

Leiderman is aware that one area that requires attention is the capital market, the banking system and the non-bank credit system, and he can be expected quickly to formulate initiatives that will improve competition, if only to prove to his detractors that the connection between him and the banks is over. He has a considerable advantage: he has spent half his life on the regulatory side, and half on the side of the regulated.

7. Internal tasks

The first task of the new governor will be to put together a new monetary committee. Half the existing committee have already left or announced their departure (Barry Topf, Stanley Fischer, and Karnit Flug), while Prof. Rafi Melnick is seen leaving as soon as Leiderman arrives.

The word is that Leiderman will choose younger people, with varied views, as against the line-up chosen by Fischer: male professors with identical views aged 70-plus.

Published by Globes [online], Israel business news - www.globes-online.com - on August 1, 2013

© Copyright of Globes Publisher Itonut (1983) Ltd. 2013

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