‘A heroine,” said Mark Twain, “would be great to live with – in a book.” If any
of the Bank of Israel’s 700 employees share this sexist concern, they can relax,
despite Karnit Flug’s operatic emergence this week as the improbable winner in
the bizarre race for the central bank’s governorship – a race which Flug never
Flug was the economic week’s heroine, but the soft spoken
economist from Jerusalem evidently lacks heroic pretensions, and can be expected
to maintain a low profile as long as external events don’t suck her into the
greater political fray.
Then again, global, regional and local dynamics
can be counted on to test Flug sooner rather than later, as she enters Stanley
Fischer’s big shoes while taking stock of an economy beset by fiscal and
monetary dilemmas as well as market paradoxes and social gaps.
IMPECCABLE scholastic credentials, including a cum laude master’s in economics
from the Hebrew University and a PhD from Columbia University, no one has
questioned the intellectual ability of the woman who had previously served as
Fischer’s deputy, an International Monetary Fund executive and a senior
economist in the Washington-based Inter-American Development Bank.
so, Flug never made it to the candidates’ pageant that produced the farce of a
four-month limbo animated by one nominee’s resignation amid an unsubstantiated
shoplifting tale, and another’s amid stories concerning astrological
Evidently taken aback by their repeated failures to fill the
vacancy, Prime Minister Binyamin Netanyahu and Finance Minister Yair Lapid
seemed unable to agree on a candidate. Reportedly, Lapid wanted Flug from the
outset, but Netanyahu preferred to seek a big name, someone who would emulate
Fischer’s monetary heroism.
Justly proud to have appointed Fischer in the
last decade, a choice that caught everyone off-guard and proved to be a stroke
of brilliance, Netanyahu wanted to repeat that act. That is how he reportedly
arrived at Israel Prize laureate Elhanan Helpman, originally of Tel Aviv
University and currently a Harvard economist who previously served as a member
of the Bank of Israel’s advisory board, clearly a worthy candidate. The only
problem was that Helpman was not interested.
Only after Netanyahu failed
in a last-ditch effort to recruit another hero, former US treasury secretary
Lawrence Summers, did the prime minister give up on the heroic option, resigned
to the anti-heroic Flug. It was a process intriguingly similar to the one that
this month crowned Janet Yellen as Ben Bernanke’s successor.
this is not necessarily bad. Since prime minister Ariel Sharon’s political
departure, Israel has generally entered a post-heroic age that began in the
military, where generals became more humble and media shy, while remaining no
less professional than their predecessors. There is some of this zeitgeist in
the passage to Flug from Fischer, and before that Jacob Frenkel.
again, the arduous road to her appointment left a bad aftertaste in the
corridors of power and beyond. The good news is that such a delay happened
before, in 1999, when Ehud Barak took two months to choose Frenkel’s successor.
The bad news is that the precedent was not good.
That governor, David
Klein, while a brilliant economist, lacked his predecessor’s charisma. He was
ultimately arm-twisted by then-finance minister Silvan Shalom, who demanded and
obtained a sharp interest rate cut – which soon afterward had to be reserved
after the shekel plunged to a historic low of five-to-the-dollar.
dynamics are not likely to transpire between Flug and the political duo she
faces. Netanyahu and Lapid believe in a strong shekel and in the central bank’s
independence. However, Flug’s is a five-year term, an eternity in Israeli
politics. Fischer, for instance, faced five finance ministers. The question,
therefore, is how Flug will fare when faced, say, with a finance minister from
Labor who will be eager to tax and spend.
In fact, this happened even
with the conservative Netanyahu, who in 2011 responded to the social justice
protests by breaching the budget deficit, despite Fischer’s protestations, which
were indeed vindicated when a NIS 40 billion budget deficit demanded this year’s
FLUG’S FIRST task, regardless of circumstances, is to
maintain price stability and a strong currency.
Price stability for now
seems relatively easy to deliver.
With inflation currently at an
annualized 1.2 percent, prices are in line with the norm in other mature
economies and well within the government’s target.
The shekel is a
different story. Having appreciated by 12% since trading last fall at
four-to-the-dollar, the shekel is becoming excessively strong from the viewpoint
of Israeli exporters, who earn in dollars and euros, but pay salaries in
shekels. This is particularly damaging for economies like that of Israel’s, or
Japan and Taiwan, which are dominated by their exports.
The Bank of
Israel’s conventional weapon in such a case is the interest rate, which in such
circumstances would ordinarily be cut, thus making it less attractive for
investors. This in turn would lower its demand and therefore also its price, or
exchange rate. However, the central bank’s key lending rate is already low, 1%,
a mere 50 basis points from its historic low of 0.5% back in ’09, following the
Moreover, lowering rates would stoke the fires of an
already overheated housing market, where prices have soared over the past six
years by 72%, making an average three-bedroom apartment’s mortgage take 135
average salaries to pay back. Now the market is so overheated that judging by
the rate of mortgage borrowing during the first three quarters, the year will
end with overall annual mortgage borrowing exceeding NIS 50b., thus breaking
2010’s record of NIS 48.6b.
Lower interest rates make mortgages seem
cheaper, and therefore boost mortgage borrowing. It follows that between its
quest to help exporters and its need to cool the housing market, the central
bank faces contradictory aims.
Fischer bypassed this constraint by
launching massive dollar purchases, totaling $52b. over five years, thus
artificially raising the greenback’s price and lowering the shekel’s, at a time
when lowering interest rates became difficult.
Flug is expected to
continue this policy. What’s more, she faces an additional challenge in the wake
of Israel’s gas production. The Bank of Israel has already announced that in
2014, it will purchase $3.5b. in order to offset the effect of prospective
foreign currency inflows from the newly exporting Tamar field.
THEN, are the kinds of market dilemmas Flug will face. But her most daunting
challenges will be in the confrontations she might be drawn to with market
Alongside the negative precedent of Klein’s encounter with
politicians, are the positive precedents of Fischer’s clash with bankers, and
Frenkel’s with industrialists.
Frenkel spent much of his nine years in
office battling a business sector that demanded drastically reduced interest
rates. Frenkel thought otherwise, never giving in to the pressures, and
ultimately reduced inflation from double-digit levels to nearly zero. At one
point he also clashed with then-finance minister Dan Meridor over foreign
exchange policy, and the clash ended with Frenkel’s victory and Meridor’s
Fischer, upon learning of Bank Hapoalim chairman Danny
Dankner’s misguided management, demanded and obtained Dankner’s removal. It was
a display of regulatory leadership and resolve that Israel had never seen, even
in Frenkel’s tenure.
Whether Flug will manage to wield such authority
over the business sector in general, and the banks in particular, will largely
decide her governorship’s success.
Israel’s banking sector suffers from a
lack of competition and a shortage of players.
Fischer’s narrowing and
capping of the banks’ elaborate and exorbitant commissions was but the beginning
of a transition that should be much broader.
Israel’s financial industry
is dominated by five banks.
The US had 25 banks in 1800, when its
population was just over 5 million people. In other words, the commissions we
pay are but a symptom of an industry that has too few banks with too many
employees and salaries that are too high.
If Flug manages to change any
of this, the middle class will surely be grateful, as such reforms will reduce
the excessive banking costs every Israeli household shoulders for no justifiable
Critics fear Flug will be a monetary dove who will tolerate
expanded government spending. Then again, she is on record for advocating
raising women’s retirement age, a conservative position that is disagreeable to
some women’s organizations. Where she will stand, and how prepared she will be
to fight on issues like income gaps between the rich and poor, senior
executives’ pay or social spending remains to be seen.
What is clear
already is that the middle class and its travails are well-known to Flug, for
the prosaic reason that she never traveled too far from it.
A mother of
two, wife of Hebrew University economist Saul Lach, and daughter of Holocaust
survivors, the 58-year-old Flug lives in a middle class apartment building in
Jerusalem’s Beit Hakerem neighborhood.
It is within walking distance from
the Givat Ram campus where she earned her BA and MA, and where she also went to
high school at the Hebrew University Secondary School – a three-minute walk from
the Bank of Israel that she now heads.
Hopefully, the visibility of all
these from her new office will make Flug complement with compassion the
professionalism all agree she has, and compensate with passion for the charisma
some feel she lacks.