The economists meeting at the annual "Caesarea conference" which takes place in Jerusalem this year found no less than four reasons why the Bank of Israel governor David Klein's rate cut last December is so incomprehensible. What possessed the governor to do it?

• First of all, the 2% cut from 5.8% to 3.8% trampled all over the central bank's policy of lowering lending rates gradually and cautiously, a policy that had inspired the public's confidence. The steepness of the cut took the public by surprise, forcing it to rethink its expectations of the central bank.

• Secondly, said the economists, the decision delivered an awkward message, as it hadn't been a Bank of Israel initiative it had been part of a package deal. "The deal showed the public that the government could participate, almost directly, in running an expansionary monetary policy."

• Third of all, the decision was reached as the government ran its own expansionary fiscal policy, in the form of a growing deficit, and the Bank of Israel customarily factors the deficit into its interest rate decisions.

• Fourthly, the decision was made just as terrorism was exacerbating the vulnerability of Israel's financial stability.

Spanked by the fans

This wasn't the first time the Bank of Israel has taken a tongue-lashing. But this time the complaint wasn't about it keeping interest too high: it was about the central bank's decision to lower the rates. More importantly, it came from people who generally support the central bank. Some of them even worked for it at one time or another. Some still do.

Klein has never supplied a sensible explanation for the 2% rate cut last December, or for his delay in reversing and lifting the rates again. In internal conversations he has claimed that some of his critics supported his moves back then.

He'll have to break his silence in the upcoming report on inflation, and in the customary annual Bank of Israel review. He'll have to explain the deviation from the inflation target set by government an uncomfortable position for the central bank, which has for years justifiably lambasted the government for its deviation from deficit reduction targets.

Although the foreign currency market has calmed down in the last few days, and most economists see inflation expectations ebbing again toward the central bank targets, the Bank of Israel's behavior in the last seven months, and the sharp upturn in inflation, will haunt us in the year to come.

The central bank's surprising deviation from its own policy, and mainly the sorry results of that its swing, hurt the good name the bank had laboriously built over seven years. That good name was one of the Israeli economy's key assets. The immediate result of the central bank's eroded reputation is that it will need to keep real interest rates higher in order to achieve its inflation targets.

If the Bank of Israel's monetary policy management had been more cautious, it could have achieved its inflation targets with lower interest. Maybe not 3.8%, but apparently less than the current 9.1%.

Nonetheless, the drama of months gone by has one upside: for the first time since the Bank of Israel turned aggressive in its fight for stable prices, all Israel's economic leaders are on board.

Hyperinflation who?

Until recently, politicians and business too had come to take stable prices, and the deriving financial firmness, for granted. The hyperinflation of the 1980s was a distant, half-forgotten nightmare.

The contribution of economic stability was doubtful, they felt, while the damage caused by the high real interest rates needed to achieve that stability was clear as day.

But anybody who took part in the live-weapons economic exercises of the spring of 2002 won't take stable prices for granted any more, or regard it as a subject befitting academic debate by moth-eaten professors.

The thunderous silence of the government ministers as the rates shoot up, and wall-to-wall support for the central bank moves, could attest that their attitude to price stability, financial stability and the Bank of Israel has changed.

The key result of this change in attitude isn't only a halt to the incessant "interest rate wars" that wore down the central bank, and may have led to its miserable decision last December,

The more important consequence is that removing the rates from the economic agenda frees space for the most important things: slashing Israel's civil service, deflating the deficit and putting a stop to rising government debt.

Participants in last week's live-weapons exercise have grasped, on their flesh, the real task of interest rates and of the central bank. Now it's time to devote attention the only instrument that can extract the economy from the quagmire the government's budget.