Israel last week edged closer to the rock-bottom interest rates prevalent throughout the Western economies.
On the face of it, there is no faulting the decision of Bank of Israel Governor Karnit Flug to reduce interest rates by 0.25% (to 0.75%). She thereby stuck to the well-trodden path of her colleagues overseas.
She gave the expected and conventional response to a set of disquieting economic indicators both at home and abroad – this despite Israel’s seemingly excellent current statistics. However, forecasts based on emerging trends are less upbeat and this is ostensibly what foremost concerns Flug.
Most economies, stuck in a stagflationary quagmire, are lethargic and going no place. All have for years counted on ultra low interest (right around zero, in fact) to inject some verve into the sluggish situation.
Cheaper money, say the textbooks, can energize listless marketplaces.
Still, the negligible 0.25% interest rate averages in Europe and America have failed to produce a lively economic bounce anywhere. The crisis of past years is apparently over, but a full recovery has not been achieved. The theory is that higher rates could hurt whatever fragile revival is already manifest.
Nonetheless, these extremely low rates create their own fallout. And since no economy is an island in our globalized reality, Israel also cannot but be affected. Its interest rates, slightly higher than what is common elsewhere, have made the shekel a relatively attractive currency to invest in and this has resulted in a strong shekel.
Yet the overvalued shekel harms exporters, whose profits take a beating in local terms. The upshot is evident in slower growth and in lower employment projections for Israel’s private sector.
The clichéd prescription is to lower the shekel’s appeal or at least prevent it from rising further. Moreover, cheaper credit might spur the private sector to hire more. In theory this looks flawless, but doing the fiscal balancing act is about as far as one can get from an exact science. In real life the drawbacks may well outweigh the advantages.
Making our exports more competitive in foreign markets per force makes imports more expensive. This potentially raises the cost of living for all of us, especially for middle class households. The inevitable outcome is less money to spend and therefore a less vibrant local economy, which is bad news for manufacturers and which is therefore liable to increase unemployment. Less buying power in time results in higher unemployment.
That is just one danger. Not unconnected is the equally cogent probability that exceptionally low interest additionally hurts savings. Most of the pain will be inflicted, as it usually is, on the conservatively managed accounts of middle class earners – who form the ultimate backbone of any economy.
Deprived of non-speculative savings options, the middle class is inevitably pushed into speculative avenues.
Among these are real-estate purchases for investment purposes rather than for primary housing. This is a major contributory dynamic to inflating a real estate bubble.
Such bubbles, in turn, make it more difficult for firsttime home buyers to save enough to buy one.
All this can likewise play havoc with our pension plans.
Particular victims are those who live on fixed incomes – like retirees. Indeed, low-income individuals – who are especially vulnerable to cost of living hikes – in the end suffer in such circumstances.
But these are offshoots of long-term processes that reduced interest rates may trigger. The BOI, like all other central banks, must foremost be vigilant about shortrange impact, even though the tiny drop in interest rates is unlikely to produce any drastic consequences for the chief economic players.
The difference between an interest rate of 1% versus 0.75% is not inherently game-changing. At most, it signals to currency speculators that they would be best advised to keep their hands off the shekel. That said, much of what happens in foreign currency trading is not a function of BOI maneuverings, but of the sorry state of the US dollar.
In the final analysis, Flug has shown that she essentially subscribes to the groupthink of her counterparts abroad, whose record, alas, is not all that impressive.