BoI Governor to continue buying foreign currency

Prof. Amir Yaron

Prof. Amir Yaron says he prefers buying foreign currency to cutting the interest rate, unless there will be a broader downturn.

A year has passed since Prof. Amir Yaron became Governor of the Bank of Israel, after turning down a position at one of the leading US universities. When he took up his position, no one thought that he would enjoy such a prolonged period of tranquility from the government and the Knesset, which have become an important player in recent years, and which have sometimes demonstrated hostility towards the Bank of Israel, its regulation, and its oversight.

Only in Israel are people still talking about lowering the interest rate.

"Right now, the correct tool we see is intervening in foreign currency, because the interest rate is a broad tool, and we do see proper economic activity. We saw the points that intervention gives us in comparison with the use of the interest rate tool. If there is a broader downturn, there will be a more concrete need for the interest rate lowering tool."

"From a perspective of a year, as soon as I arrived, I saw that it was necessary to adapt the Bank of Israel to the new economic situation. The Bank of Israel should be one step ahead of all of the economic events, and should help the Israeli economy," Yaron says. "This requires long-term thinking and planning, and challenging the accepted wisdom. Here I go from extremism in consideration of monetary tools to structural changes within the Bank of Israel. This is where the strategic plan comes from. We're at its very advanced stages. I believe that we'll issue the summary document in the coming months, when we feel that the structural changes have gotten to where they should be."

Stanley Fischer left his mark in the form of the Bank of Israel Law. Karnit Flug left the Financial Stability Committee. What about Yaron? He says that his pet project is assimilation of technological innovations in banking and payments. "I thought it right to diagnose and analyze closing the gaps and adapting the Bank of Israel to changes in technology, with an emphasis on the payments and capital market systems," Yaron explains. "This is an important mission, and there's no doubt that the financial situation of every household and every business will be benefited by the changes that technology can bring, and by improvement of the market. I think that in my term in office, people who want to make all of their payments digitally will be able to do so. I believe that the credit and financing market will also be more advanced, better, cheaper, and fairer."

"Globes": What about the digital currency idea?

"The payments sector will be completely different. Before my term is over, people will be able to make payments using digital means. We're giving in-depth consideration to a central bank digital currency (CBDC), including the development of thinking about an innovation laboratory and cooperative ventures with colleagues from around the world."

Then innovation is a goal.

"Innovation brings more things with it. We live in a world in which the number of changes is growing, and they are becoming more frequent. It's therefore becoming critical to develop the Bank of Israel's ability to exist in a state of uncertainty, because uncertainty is the regular state of affairs now. We know that the deepest and most painful recessions are those that accompany financial crises, so it's very important to prepare the Bank of Israel, the Israeli economy, and the financial systems for such situations. This is where the Financial Stability Committee is a very important factor, but I'm talking about something deeper and more integrative."

"I don't like taxes, but…"

Yaron talks about his job in comparison with his counterparts in other countries, and he describes a very special situation. "One of the things that is different about the job of Governor of the Bank of Israel in comparison with other places is that he or she also serves as an economic adviser to the government in order to improve the Israeli economy for the public's benefit, and I'm talking about both the current generation and the future generations. The Bank of Israel's job is to be professional and channel policy toward where it should go, and it's best to work with clear goals."

How unusual is it for a central bank government to also give economic advice to the government?

"It's very unusual."

Is it also a problem?

"I don't know if it's a problem. I wouldn't say a problem but it's certainly another aspect. It's obvious that the job of Governor of the Bank of Israel is an important and powerful position. At the same time, here you start doing the job, and you see the challenging width of the characterization of many things. It's a great responsibility making decisions for the benefit of the economy and Israel. In this sense, it's more powerful than in many other places. I knew that the position was powerful from the start, but this is another element that greatly expands the issues that you have to deal with. Some of these matters are things that governors of other central banks don't have to deal with at all, not mention that they don't have to attend all sorts of meetings - they simply aren't there."

Does this create clashes?

"We've gotten along fine until now, and there's good cooperation with all of the ministries and government agencies. But there's no doubt that this involves issues that involve more government ministries and politics than in other countries."

During your predecessor's term, there were two main bones of contention between the Bank of Israel and the political leadership. One is intervention in the foreign currency market, and the other is raising taxes. Can it be said that your policy on these two points is a continuation of the policy of the preceding governor?

"When the Bank of Israel's report was presented, we cited the structural deficit, and said explicitly that it had to be dealt with. The markets are giving Israel a lot of credit, because we managed to lower the ratio of debt to GDP below 100%, and to stabilize it at around 60%. There's a lot of confidence that we'll continue practicing fiscal responsibility. This is a strategic asset, and must be preserved. This is the lighthouse I want to aim at.

"It's very important to make up this structural deficit. I don't respond every time there's some sort of number, because what's important is the direction, and that the debt-GDP ratio converge around 60% in the short term, and be credible. How should this deficit be made up? Fiscal convergence can be achieved by economizing, increasing revenues, and taxes. In the end, it has to reflect the incoming government's priorities. I also said that civilian spending is not high right now, so it won't necessarily be easy to accomplish this with just the first two elements. Nevertheless, I want to emphasize that I don't like taxes."

Yaron also comments on the fact that the state budget has not been approved, and that the state is operating on a continuation budget. "We have to close the budget deficit using the first tools I mentioned. Meanwhile, there's the continuation budget, and if it continues for the whole year, and I hope that this doesn't happen, we're talking about a deficit of just over 3%. There may be debt alternatives that will lower it a bit below 3%, but keep in mind that even if we find ourselves at this point, any incoming government will still have to contend with the same obligations, the same projected spending, and make decisions to continuing making up for the deficit. We'd like fiscal convergence to take place through an across-the-board review that analyzes where cuts can be made."

What about intervention in the foreign currency market?

"We have models and professionals to decide where the exchange rate should be and what window supports price stability, inflation targets, and proper economic activity. At the same time, we're taking into account exporters, importers, and consumers.

"We're also looking at financial flow, at the current point in time, and also looking towards the future. I believe that as long as we're within the window, I have a clear preference for the market to manage the exchange rate. At the same time, when we see a deviation, we take action. It's important for me to make it clear that there's no change in policy here; there were two realizations within the policy. There was a period in which we were within in the window, and now we’re in a period when that's no longer the case."

One of the criticisms of Yaron's policy and the consideration that he mentioned is that the Bank of Israel gives too much weight to supporting exporters. Yaron comments, "Our analysis is not just of the exporters; there are many other aspects. We weigh all of these things."

Since the renewal of foreign currency market intervention in late November, the Bank of Israel has purchased over $7 billion. We have not seen these amounts for years, and the shekel-dollar rate nevertheless has remained almost unchanged. Are you disappointed?

"What interests us is the principle of the window; the volume is not the decisive criterion. The Bank of Israel intervened in the past when it was expensive. It's more the principle of whether we should intervene in order to support an exchange rate that supports targets. The cumulative shekel appreciation was the second steepest last year, after the Russian currency. But we see that since the intervention began, almost all of the currencies have strengthened against the dollar, and we've stayed in the same place. We're also examining how the players in the economy are coping in the exchange rate conditions."

Is the Bank of Israel's intervention in the foreign currency market designed to give the market time to adjust?

"Within the element of economic activity, there's also a value of gradualness, so that non-financial economic concerns don't find themselves suddenly exposed to a substantial change for which they have no time to prepare."

You are talking about time to prepare, but this has been going on for eight years.

"We see the structural change in the economy. The economy is moving towards knowledge-intensive technology that's less affected by it."

One of the biggest tasks of the central bank in Israel, or any central bank, is maintaining price stability, with a slow, steady increase that contributes to growth. In recent years, many central banks have not met their inflation targets, due to the exceptional state of the world's economies, with an emphasis on the central banks since the great economic crisis in 2008. Central banks have a number of tools for meeting this target, starting with the interest rate.

Addressing this point, Yaron says, "In general, the inflation targets regime did a good job, and I think that it will continue doing a good job, in ensuring the prosperity of many economies over three decades. The fact that for a specific period, quite a few countries have been having trouble meeting the long-term inflation target - and we're not the only ones, as I see from talking with US Federal Reserve chair Jerome Powell, Governor of the Bank of England Mark Carney, and European Central Bank chairperson Christine Lagarde - is not enough reason in itself for changing the target. What's important is that the various players in the market need this compass that we call the target, and which determines by what rate the value of money will change over time. The Bank of Israel has adopted an inflation target regime of 1-3%, and has contained the drop below the target without using any extraordinary tools, to a large extent because inflation fell for a good reason, while the economy continued growing and unemployment fell. Part of this is a reflection of increased competition, but inflation shouldn't be confused with the cost of living - they're not the same.

At the same time, we have to continue aiming at the inflation target as it is. This is very important. In the first stage, we need to bring inflation within the target range, and later bring it to the middle of the target range. This is essential in order to normalize the interest rate. What does 2% give? It's a compass that the players need. We want expectations for two years and later to be 1.6%, and if a negative business cycle occurs, it gives the central bank a margin for action without taking exceptional measures (this refers to a negative interest rate, A.B and R.S.)."

But are you reassessing the inflation target?

"There are quite a few central banks considering the inflation targets. Some of them are talking about raising the target in compensation for the period when inflation was below the target. The Bank of Israel is also analyzing the causes of inflation. We see that there are a number of forces operating in different directions. On the one hand, we have a properly functioning economy, with rising wages, and as long as wages rise, it causes inflation to rise. On the other hand, there is an effect of globalization, competition, the effect of the change in the energy market and the shekel appreciation, which are pushing the commodities index down. The Research Department's forecast states that between these two forces, as long as economic activity is proper, we see ourselves moving towards the bottom of the inflation target range in the second half of 2020 and in 2021. Assuming that these processes continue, inflation will continue rising in the direction of the middle of the target range."

Are there conclusions from the reassessment process, Will you raise the inflation targets, as the US did?

"There's a built-in process. In the US, they began the process a year ago, and it can be expected to take another year. Lagarde only began it now. I don't want to make predictions about what I think. We'll see while the process is going on what happens in the rest of the world. There will be points that we tell the public about, and I'm aiming to get insights by mid-2021. I want to get back to foreign currency. Right now, we regard intervention as them most direct tool on those points of price stability, and regard intervention as a more direct tool than the use of broader tools like the interest rate."

Is there an element of a currency war in the central banks' policies?

"We see low interest rates in Europe, and also in Japan. There was a policy of raising the interest rate in the US, and they stopped it, because there was some slowdown there. The forecasts of investment houses and the OECD and IMF for 2020 and 2021 talk about lower growth rates in the main blocs than in 2019, although the feeling in Europe is that we're reached the bottom. On the other hand, on Brexit and the trade war, there is less fear about extreme events liable to result from them. It can be said that 'The expectation of crises is lower, and the variance is also lower.'"

We have already experienced many years of expansive monetary policy. Many people argue that the central banks have created bubbles in the capital markets. What is your opinion?

"There's no doubt that among other things, monetary expansion supports financial multiples to some extent. I won't discuss the question of whether or not this is excessive. In the financial stability report for Israel, the risks we see are by and large reasonable. We may have pointed to underpricing of corporate bonds, and that may also be true in other places, such as the US, that have corporate bond leverage and collateralized loan obligation. There's no cause for panic; I'm just saying that relatively, I want to be very cautious, you always have to monitor risks. You have to look at the value of the multiples and examine whether they are appropriate for economic activity, and part of the discounting here is obviously also related to monetary expansion."

Is the end of the quantitative easing era in sight?

"It doesn't look like the Fed has any appetite for lowering the interest rate any further, unless there a substantial downturn in the economy. In Europe, also, I think that they are not eager for further expansion."

Published by Globes, Israel business news - en.globes.co.il - on January 29, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Prof. Amir Yaron
Prof. Amir Yaron
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