"If there was an element of failure in the stabilization program, it was the tardy and inadequate adoption of structural reforms. Following the stabilization program there were certain reforms in the capital market and in trade, but privatization, the reduction of the government's role in the economy and the removal of barriers to competition proceeded slowly," last night said Governor of the Bank of Israel Prof. Stanley Fischer.
Fischer addressed the opening session of the Israel Democracy Institute Conference on Economic Policy (the Caesarea 2005 conference) in Jerusalem. The session was devoted to "The Economic Stabilization Program, Twenty Years On." At that time, Fischer been a senior advisor as a member of the US team working with the government of Israel.
Fischer said, "Growth after stabilization was disappointing, and even in years of growth, such as the mid-1990s, additional reforms should have been implemented which would have led to faster and more continuous growth.
"In the last decade great progress has been made in this sphere: capital flows have been liberalized, more rapid progress has been made in privatization, reforms have been introduced in the field of taxation, and today we stand on the threshold of a very important reform of the financial systemthe reform recommended by the Bachar Committee."
Fischer noted other conclusions. "An important lesson to be learned from the 1985 Economic Stabilization Program (ESP) is in the area of the Central Bank Law. As part of the ESP the Bank of Israel Law was amendedan amendment known as the Non-Money-Printing Law, which since then has prevented the Bank of Israel from participating in financing the government deficit. This amendment was essential for the success of the ESP, and provided the Bank of Israel with the infrastructure to carry out its monetary policy.
"Another lesson relates to policy. The recession of 1988 and 1989 that followed the introduction of the ESP was not inevitable, but resulted from an error perpetrated at the outset of the programthe sharp rise of 12 percent in the real wage in the first three months of 1986. This led to increased demand, and rapid economic growth. The Bank of Israel then had to raise the interest rate to prevent the resurgence of inflation, and this brought about a recession that could have been avoided.
"The third conclusion to be drawn from the ESP is the importance of structural reforms.
"The fourth lesson is in the area of exchangerate policy. In the last eleven years, since the Mexican crisis of 1994, almost every major financial crisis started from the combination of a fixed exchange rate and free capital flows. The use of a fixed exchange rate as a nominal anchor in the stabilization program was essential. But it is much easier to use the exchange rate as a nominal anchor when capital flows are supervised, as opposed to a situation of liberalization.
"The fifth conclusion to be drawn from the ESP is the importance of the financial system. If we examine the costs of the crises in the last ten years, we will see that the most important factor was the resilience of the financial system, and in particular, that of the banking system. In some aspects we are still today paying the price of the financial crisis that occurred at the end of 1983, which resulted in the nationalization of the banks that had participated in the manipulation of share prices and that the government even today is working so hard to privatize."
Commenting on the reforms he intends to implement at the central bank, Fischer said, "To build a modern economy, further basic reforms are needed, such as a new, modern Bank of Israel Law in line with the norms accepted in the advanced countries, and completion of the reform of the capital and money markets, e.g., passing a Repo Law."
Published by Globes [online], Israel business news - www.globes.co.il - on Wednesday, June 29, 2005