Last year, Bank of Israel governor David Klein kept repeating that Israel is not America. Therefore, he explained, he could not ape his colleague, Federal Reserve chairman Alan Greenspan, by slashing interest rates to jumpstart the economy.
Klein was right. The U.S. has long since eradicated its inflationary tendencies. Its bonds and money markets are the most sophisticated in the world, and its budget deficits are slim. Therefore, in the U.S., interest can be used as a key tool of anti-cyclical policy.
But in Israel, anti-inflationary culture is not dead yet. The economy is riddled with linkages and inflationary habits. The capital market is largely still nationalized, and persisting budget deficits undermine the reliability of any anti-cyclical policies. They also exacerbate the risk of accelerated inflation, and of deepening the recession.
Thing is, around the end of 2001, Klein ignored his own wisdom and cut interest rates by 2%, based on promises by the prime minister. The markets spiraled into a maelstrom whose full results became evident on Monday, when Israel learned that consumer prices had climbed 1.3% in June, completing a 6.3% rise from the beginning of the year.
Even if the CPI turns negative in some of the months to come, 2002 will clearly end with inflation of 6.5% at best, 8% at worst three times the Bank of Israel's target.
A few questions the Knesset could ask
We can therefore say, with caution, that Klein's very lucky this isn't America. If Greenspan were to allow American inflation to spiral out of control like that, within 48 hours Congress would have crucified him. And if he survived his skewering, he'd be left shaking on the sidewalk calculating his unemployment benefits.
But this isn't America and our leaders couldn't care less about financial stability or inflation. Our Knesset members habitually skewer the Bank of Israel over the one thing completely outside its sphere of influence: growth, and jobs creation.
If our elected representatives were serious officers, instead of being serial headline-chasers, they'd have Klein on the floor facing a grilling:
• Why has inflation this year jumped to 6%-8%? How did it happen? Was it because of the
? The budget deficit? Private bills? Or mistakes by the Bank of Israel's monetary policy in the last year?
• If it isn't the Bank of Israel's "fault", if the blame lies with the government's expansionary fiscal policy does that mean the central bank cannot control inflation when the Finance Ministry expands the deficit?
Does the central bank have the tools to exterminate inflation? Or, are we reaching the point where without dramatic fiscal action, we will lose our achievements regarding price stability?
And, if the central bank does have the tools to exterminate inflation, then why are we blithely accepting such high inflation?
• In October 2001, you said it would take two to three years of disinflationary policy until the central bank could lower real interest rates to Western levels, without risking an inflationary outbreak.
You noted that much of the public's savings are still in vehicles linked to consumer prices, indicating that conquering inflation still needed much work.
But two months later you slashed lending rates by 2% to Western levels. What happened between October and December 2001? How many years do you now think high real interest will remain?
Have you returned to the view that the public's portfolio of assets much fundamentally change before the Bank of Israel can declare an expansionary monetary policy as a way to boost the economy without imperiling stable prices? Do you mean to stick to that policy, or under the appropriate circumstances, might you take "recesses" for deals with the PM?
• When you missed inflation targets in the past, from below however, you said there was no sense in measuring inflation using "calendars" what matters isn't inflation in a specific year, but the inflation environment over time.
Sounds reasonable. But is there no danger that such a steep rise in inflation, in a single calendar year, might cause sustained injury to the Bank of Israel's credibility, and reverse the economy's progress in abolishing linkages?
• At what rate of inflation need the calendar year end for you to address the people, and tell it one of two things: "Under the current fiscal policy led by the prime minister, the finance minister and the Knesset, I can assure that we will continue to approach price stability" or, "I was wrong. I will not repeat my mistakes. It proved costly. My predecessor, Professor Jacob Frenkel, also made mistakes like these but what matters is that from this point on, I will stay focused solely and only on price stability."