Bank of Israel has exhausted its options

Ron Eichel

The government, which has avoided implementing important housing measures or channeling money to stimulate projects, must now join hands with the Bank of Israel.

The Bank of Israel faces a disturbing reality. Inflation is very low, so it wants to promote the most pressing goals, such as growth, income distribution, and combatting unemployment. The wish is there, but as for means - that is a whole other story.

The Bank of Israel's most burning issue today is the strong shekel, which is an obstacle to exports, and through them, growth. The last interest rate cuts (the double cut in May and the announcement in late September) were intended to change the direction of the shekel-dollar exchange rate by weakening the shekel against the dollar.

Clear evidence of the importance that the Bank of Israel attaches to the exchange rate is that, after a year of remaining dormant (2012), it resumed its purchases of dollars. It is true that the Bank of Israel has a mandate to buy foreign currency as it sees fit, but appearances are important.

The Bank of Israel has a reason to buy dollars. It has set a target of the necessary foreign currency reserves. In 2008, when it began buying, it said that $39 billion was the necessary level. Today, it is talking about double this level. Obviously, the economy has not doubled in the five intervening years, so we can assume that the definition was expanded to justify purchases.

In any event, bottom line, Israel's foreign currency reserves per capital are among the highest in the world: $10,000, compared with the OECD average of $4,600. In other words - more than double.

It can be argued that Israel is different; we have security problems, and a small and open economy. Nonetheless, South Korea (which has a security problem that is no less than Israel's) has just $7,000 in foreign currency reserves per capita. The Czech Republic, which has 10 million residents (not many more than Israel) has $4,700 in foreign currency reserves per capita, and Hungary has $4,200. In other words, we're at the top, and even if we are special, it is hard to justify additional wholesale purchases, which carry an immediate economist price.

As for the interest rate, the economy has fully realized this option. In economics, this is called a liquidity trap, in which the interest rate has reached a level at which an additional reduction is ineffective. In popular language, it is the level at which banks stop lowering their interest rates on loans for us. The Bank of Israel has several other tools to promote its goals, but they are ineffective, compared with the interest rate weapon or foreign currency purchases, which have a precise effect on the exchange rate.

The problem is that the Bank of Israel's main tools are exhausted. In other words, the Bank of Israel can longer help strengthen economic activity with its standard tools. The government, which in the past few years has avoided implementing important housing measures or channeling money to growth stimulating projects, must now join hands with the Bank of Israel to work together.

Regrettably, the era in which the Bank of Israel could deal with and solve problems that the government chose not to deal with is over. In practice, the Bank of Israel's monetary tool has become the government, and the only way the Bank of Israel can get the government to act is to persuade the finance minister and maybe the prime minister that it is right. In other words, now more than ever, there must be cooperation between the Bank of Israel and the government.

It seems that the term of the new governor will be much more political and less analytic than her predecessors.

The author is a macroeconomics research and capital markets strategist.

Published by Globes [online], Israel business news - - on November 14, 2013

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

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