Karnit Flug had big shoes to fill when she was finally sworn into office as the Bank of Israel’s governor in November 2013.
Her predecessor, Stanley Fischer, was the darling of both the political and economic worlds, a mentor to the most prominent central bankers in the world – including former US Federal Reserve chairman Ben Bernanke and European Central Bank President Mario Draghi. The process of choosing a successor was a drawn-out - some would even say farcical - affair in which two nominees stepped down following harsh media coverage, while Flug was nearly overlooked.
But Flug, who was Fischer’s deputy, has come into her own as the first woman to lead Israel’s central bank and the chief economic adviser to the government.
She has proven she is not afraid to take bold steps, decreasing the interest rate to a historic low of 0.25 percent in August, where it has remained since, and hinting she would be willing to use “other tools” such as quantitative easing if necessary. She has gone headto- head with former finance minister Yair Lapid, making her case against policies such as his defunct zero valued-added tax housing plan, in her soft-spoken yet direct style.
Indeed, in its yearly report card on central bankers in October, Global Finance magazine rated Flug as one of only seven bankers with the top mark of “A.”
In one of her first newspaper interviews since taking the Bank of Israel’s helm, Flug sat down with The Jerusalem Post in her office and discussed her views on issues ranging from inequality to Bitcoin regulation to the threat of boycotts on Israel.
Well aware of the political sensitivities of maintaining an apolitical stance, especially in the run-up to an election, Flug treaded cautiously around the more explosive issues, but still gave insight into what Israel needs to do to fix its toughest economic issues.You’ve made history as the first woman to lead the BoI, and one of the few female central bankers in the world. People often talk about the challenge of being a woman in male-dominated fields, but how has being a woman been an advantage for you in the field?
I’m not sure I have a good answer for you; I don’t know if it’s been an advantage or a disadvantage.
I actually never felt that it affected the way I operate, maybe because I have spent most of my career at the BoI, where there has been always a very gender-blind attitude to economists and managers.
Actually, at the BoI, the representation of women at all levels of management is exactly [the same] as their share in overall employment – we checked that – so it really has not been an issue.
There are some areas, such as hi-tech, where there are fewer women than potentially could be, and I think that sometimes it takes more openness on the side of the employer and more flexibility in the way the workplace is set up; it also takes some adjustment in the family structure.
I know that in my career, the fact that I have a partner who was always a full partner in everything in terms of running the home and taking care of the kids, was very helpful.
It requires two to tango, also in terms of family and at home, but a different division of labor – which is not always that easy to achieve. I think it’s part of a gradual process, and will be helpful in terms of having more women reach their full potential.
I do think having women reach top positions sort of paves the way for other women, in the sense that you can actually do it and combine having a family and having a career. Doing okay in this respect is probably helpful for women earlier on in their career, when they’re thinking, “Can I really do it and combine it all?”
There will be a new government coming into power in the next few months. What should its top economic priorities be? What advice would you give the next prime minister, whoever that is?
I think the main objective of the economic policy should be sustainable and inclusive economic growth. And I think towards that goal, there is a need to work on increasing the productivity of the business sector; that is based on infrastructure, promoting innovation, improving the business environment – we don’t score very well on the “doing business” ranking of the World Bank – improving skills via vocational training, improving the education of all parts of society. These are the broad categories.
I think there is a need to continue very sustained efforts to integrate groups that have low rates of participation in the labor market, mostly ultra-Orthodox men and Arab women.
In spite of improvements, there needs to be more efforts in terms of training, skill [building], all sorts of barriers that need to be removed for creating a more open and welcoming environment within the business sector.But we have seen some mild improvements in these groups recently. Do you think efforts need to be ramped up?
Definitely. Given the poverty rates in these two communities and the fact that they’re becoming a very significant part of Israel’s population, the efforts for them to get integrated need to be continued, sustained and expanded.
Another challenge is the housing sector, and there I think the big challenge is how to sustain a high level of housing starts and housing completions, including also in high-demand areas – meaning not only in the periphery – and I think the efforts there have borne some fruit in terms of higher number of housing starts in 2013 and 2014. But this needs to be sustained.
Everyone recognizes that there needs to be more supply to bring down the cost of housing, but what’s stopping it? What are the choke points we can address?
I should begin by saying I don’t think there is a quick fix. The process of building a home is a very long process.
We describe all the stages in one of our reports, and according to that, it took 13 years from the very start to the completion.
Some steps have already been improved, for example, the planning process in some areas has been shortened in some ways, but I think every step needs to be shortened.
And then there’s the construction itself, and the need to remove other barriers such as infrastructure. Sometimes you complete the building process, but some parts of the infrastructure are still not there – and that makes it impossible to actually deliver and occupy the neighborhoods.
It’s very important that in the pipeline, we will have enough planned land so that you can actually put out and auction a sufficient amount of land, so that you can have the high level of housing starts – which needs to be over 40,000 or 45,000 units a year, sustained for an extended period of time.Will breaking up the Israel Lands Authority [as Koolanu leader Moshe Kahlon suggests] help put more in the pipeline?
I have not studied that plan, so I don’t want to give any specific recommendation as to the structure of the system.The central bank is struggling with inflation that is below its target range. Why do people think the cost of living is so high if price inflation is actually negative?
I think there are some areas where prices have gone up more than others, notably the price of food – which went up more than the average increase in CPI [Consumer Price Index] – and these are prices we meet frequently in the supermarket, so that’s part of the issue.
One element [contributing to] the sense of an increasing burden on households is the fact that for some of the services, such as education and health, there’s a substantial out-of-pocket payment.
I think the fact that home prices, which are not part of CPI, have gone up substantially also adds to the sense that the cost of living and hardship are there, so that’s part of the story.
But I think the cost and standard of living are multidimensional questions, and you have to look at the side of income. Wages have gone up moderately in real terms, so that’s also part of the complex picture, and if you look at what happened to disposable income, that actually has increased in the last 10 to 11 years in line with an increase of GDP per capita, so that’s the half-full glass.
It’s increased at roughly the same percentage for the lower quintile [e.g. the poorest 20% of the country] as the upper and middle quintiles – yet the sources of this increase are different. In the lower quintile, that source of disposable income implies more labor income from higher participation, more wage earners per household. The upper quintile has benefited more from the reduction of direct taxes.
But again, looking at this disposable income is only part of the picture, because if there are more people who go out to work there are also more associated costs like childcare. So in that respect, even looking at the disposable income doesn’t give you the full picture. It’s a complex issue.In addressing the economic challenges the country faces, there are several approaches: increasing competition and breaking monopolies, redistribution through taxes and benefits, and lowering bureaucracy. Which of these is most important to Israel?
I would say all of the above, and more.
In tackling inequality, the main issue is providing the adequate skills so everyone can be incorporated with the kind of skills that can provide them an adequate wage.
The fact is that we have some industries with low productivity, especially those that are focused on local markets and have low productivity or output per worker, which implies they pay relatively low wages, so we have a large part of the labor force getting low or moderate wages.
I also think a factor is that industries which are geared toward the local market have less competition, so in that respect, enhancing competition is essential because it will force them to increase productivity.
And I think the entire business sector will enjoy a better business environment, including in terms of regulation and bureaucracy, and here it’s mostly a problem of coordination.
When you have many regulators regulating the same industry, sometimes the regulation is inconsistent or incoherent – and that makes it very difficult for these industries.On the budgetary side of things, we haven’t been good at sticking to our fiscal targets in the past few years, and we keep pushing off plans to reduce them. What should the targets be, and how can we make them stick?
Generally, the deficit targets [specified] in the law are reasonable, and they should bring the debt-to-GDP ratio by the end of the decade to 60% – which I think is a good target. I have to say, even if we stick to the spending rule that was adopted by the government, which implies an increase in spending of 2.6% annually in real terms, that will require some increase in tax revenue down the road, preferably by eliminating some tax exemptions currently in place.
What has made it difficult to meet the target is that sometimes, when we look at the way the government has been operating, it has made a lot of specific commitments on spending that are long-term, and there is no mechanism that makes all of these commitments consistent with the spending rule, which was also adopted by the government.
So I think we need a mechanism to ensure we follow the specific commitments, and that they are consistent with the overall spending limits – and we have not done that. It makes it difficult to have a set of rules that are not always consistent with each other.
Can you provide some examples of tax exemptions we should eliminate?
I can give you a whole list – there’s a report on all the tax exemptions by the State Income Administration – but I don’t want to single out specific examples. I think each one should be reviewed according to the goal it was supposed to be serving, and whether it’s supporting that goal. And I think some of them are likely not quite serving the goals they intended.What about raising other kinds of taxes, such as corporate or capital gains?
It will be a government decision, according to trade-offs. Some taxes are more efficient in that they have a broad base, but they’re regressive in that they don’t decrease inequality. Direct taxes are more progressive but less efficient.On the spending side, what should we prioritize in the budget?
I think you have to take into account that our overall government spending is not high. It’s lower than the OECD [Organization for Economic Cooperation and Development] average, and if you take into account that we have much heavier spending on defense and spend more on servicing our past debt, our civilian spending – all the services including education, health, welfare and also engines of growth like infrastructure and R&D – is very modest in terms of GDP, compared to the advanced economies.
In fact, we’re next only to Korea – the only country that spends less than us in terms of GDP on civilian spending.
Unlike the early 2000s, when our government size was quite high relative to GDP in any international comparison, now the size of the civilian spending is quite modest. So the big challenge would be how to provide higher-quality services, especially in areas like education, which is very important for long-term growth; on infrastructure, which is very important; and some specific engines of growth to help support economic productivity, which is very important in terms of the performance of the public, of the individuals in the economy.
There’s a serious debate over the Israel Antitrust Authority’s actions in the natural gas market. What’s the best outcome for the ongoing negotiations?
There are ongoing negotiations, so it’s not a good idea to comment at this moment.Some politicians [editor’s note: specifically Kahlon] have criticized the BoI’s recent stability report, which cited the threat of the housing market to the financial system and talked about steps to restrict mortgages.
They said it puts banks’ financial stability over people’s needs. What’s your response?
I think that financial stability, together with competition and fairness, is very much in the interest of every citizen and household in a country. We’ve witnessed crises [around the world] that included a financial crisis or bank failures, and the cost in terms of human suffering in those countries was much more severe – and there are empirical results on that – than countries that did not experience financial crises or bank failures.
So I think when we talk about financial stability or the stability of banks, we are thinking of the good of households, consumers and people.
I would add that in those places that did experience these failures, it was the taxpayers who paid for cleaning up the mess – and the costs were huge.
I do believe that part of maintaining bank stability is also fair behavior on the part of the bank toward its customers, and I think banking supervision has made a lot of progress in that respect – so I don’t see a conflict between maintaining financial and bank stability and the welfare of the public.
I also don’t see a conflict with promoting competition, as was consistently done by implementing the recommendations of the competition committee headed by [outgoing Supervisor of Banks] Dudu Zaken.
The fact that it’s much easier to transfer your account from one bank to another or open an account on the Internet or have all the information provided in a way that you really can compare them, and having a set of services at a fixed price of no more than NIS 10 a month – all of these steps are empowering households vis-a-vis the banks. Additionally, I’m sure the other recommendations will be implemented one by one to really enhance competition, also for the household and small-business segment of provision of services.
One of the issues we’ve been trying to implement is a recommendation that was made by the International Monetary Fund based on the experience of other countries, to set up a financial stability committee that will look at all parts of the financial system and monitor risks. The financial stability report is part of how we interpret our role in supporting financial stability; we set up the infrastructure in the form of a special financial stability division, and this report is part of that infrastructure.Moving to monetary policy, we have an interesting dilemma here with two important trade regions. The euro is down in the dumps, economically stagnant and about to embark on quantitative easing, while the US economy is perking up, tapering its QE, with an interest rate rise coming down the line. How do you balance that in formulating Israel’s monetary policy?
We basically look at how it all affects the Israeli economy. Both these regions are very important trade partners, and at the end of the day, we look at what’s happening at the demand to our exports combined.
In that sense, I think we’ve seen over quite a substantial period now, stagnant growth of world trade – which basically combines the effects of the developments in each of these regions and in other regions as well.
That has been a challenging environment for our tradable sector, and our economy as a whole. Our monetary policy responds to the overall effects on inflation and trade activities.
Obviously, the ability to export to a region which is important but not growing has become more difficult, and if you add the fact that the euro is weakening, this makes the ability to compete and actually export to Europe and/or compete with European countries in other markets more difficult.
We actually visited a company in the Gaza envelope yesterday that produces feeding machines for cattle, and they told us about how they reoriented their export destinations to reduce the share of Europe and move to other countries, and also change the currency at which they make the contracts away from the euro to the US dollar. So at the micro level, you also see what you see in the statistics – a shift and diversification of export destinations.How will Greece’s new government affect Israel, with the installation of left-leaning Prime Minister Alexis Tsipras, and what do you think is the best outcome for Greece and the Europe?
I think what is crucial is what the effect on Europe will be. I hope that eventually, whatever the solution is, it will not have a detrimental effect on the ability of Europe to undergo a recovery. I don’t want to get into commentary about specific developments.
By the way, another interesting development in Europe was the fact that the Swiss decided to abolish the currency floor vis-a-vis the euro, and that’s interesting as an experiment – because until a year ago, there were quite a lot of debates in Israel and quite a lot of supporters for adopting a floor for the shekel. Obviously, we don’t know yet whether the floor served a beneficial role for the Swiss for the period it was in place, but clearly with these policies that are not flexible, you have to think about the exit when you adopt them, and for the Israeli economy, I think it was important for us that we maintained the flexibility of our monetary policy, and that we resisted some of the pressure to adopt an inflexible policy.The BoI doesn’t have any lower to go on the interest rate, but you have spoken about “other tools.” What are you referring to?
Let’s start with the fact that right now, according to projections by our research department, after a period of very low inflation – affected by government-initiated price reductions in water and electricity, as well as the effect of lower oil prices – we do expect to see inflation gradually moving up, and to be close to the lower bound of our inflation target within a year. If you subtract the effect of the price reduction of electricity and water, we would actually be standing at 1.5% inflation according to that projection of the research department, based on an interest rate at the current level. That’s the baseline projection.
So although other tools, if needed, could be used, we will only use them if we think they are really needed, and then we’ll tailor them to the circumstances. Now, the kind of tools I refer to are generally those that have been used by other advanced economies once they’ve reached the zero bound.It sounds like you’re saying that the possibility of using these tools has become less likely?
I think that as I described the projections, at the moment it is not something imminent.
But we will use whatever tools are necessary.Do you believe the threat of political boycotts is a serious one to the economy?
I think for the moment, we have not seen any substantial effects from boycotts. We haven’t seen substantial boycotts either, and I think the Foreign Ministry is really monitoring that and trying to at least identify it early on. Having said that, being a small, open, export-oriented economy, open and welcoming markets are an important factor in our performance.
How should Israel deal with virtual currencies like Bitcoin: Should they be recognized? Regulated? Held in reserve?
We have a committee headed by our research department that looks at the question of whether we need to adopt any measures or take any action on these issues from all the perspectives. We did issue a statement warning the public on the potential risk of this new currency, because people that get involved in dealings with Bitcoin have to be aware of risks of this new facility.
This interview has been edited for length and clarity, with the approval of the Bank of Israel.