Fischer’s priority: Fighting inflation

Dealing with medical crises, physicians often face multiple maladies, forcing them to make difficult calls, choosing what to treat first.

By JPOST EDITORIAL
stanley fischer 311 (photo credit: Courtesy)
stanley fischer 311
(photo credit: Courtesy)
When dealing with medical crises, physicians often find themselves facing multiple maladies, forcing them to make difficult calls and choose what to treat first. Economics can present similar predicaments.
Some syndromes demand priority, because they are judged as more detrimental overall. Even when such decisions are eventually vindicated, they are by nature speculative and risky because no absolutes exist and there are no airtight assurances that one anomaly indeed deserves precedence over others.
This is precisely the dilemma that plagued Bank of Israel Governor Stanley Fischer this week as he announced the single highest interest rate hike in recent years – a full half-percent. He had already raised rates by one-percentage point in 2011’s first quarter alone, and by no less than 2.5% since August 2009, when he became the first central bank governor internationally to raise interest in the aftermath of the global recession.
This is among the highest climbs anywhere and, against the background of rock-bottom rates abroad, is atypical enough to look perplexing. But there is method here, not madness.
Fischer’s twin challenges are both substantial – gathering inflationary clouds and the need to restrain the local currency. Making things worse is the fact that these two dangerous trends feed off each other. Anti-inflationary moves will inordinately boost the shekel even further, while keeping the shekel at a realistic level will generate more inflation.
For a long while, Fischer strove to maintain a delicate balance between the two contradictory dynamics. His latest move indicates that he has given up the simultaneous concentration on both ills. This is tantamount to a game-changing declaration of intent: Fischer will now categorically focus on inflation.
In other words, Fischer has unambiguously identified inflation as the greater threat – more immediately pressing and more destructive in the long run.
OUR ECONOMY is growing at a faster pace than most western economies and while this is good news, it can also easily trigger an inflationary spiral. Our past attests to Israel’s proven susceptibility to this affliction.
At present our inflationary rate hovers around the 4.2%, considerably above the 3% upper limit of the Bank of Israel’s target zone. The feverish real estate and mortgage markets are the primary harbingers of unwelcome tidings. Nothing attempted thus far to cool them down has worked. Higher interest may theoretically dissuade home buyers from borrowing more than they can afford, but it’s doubtful this alone would suffice.
It may be that the Bank of Israel is too late in its attempts to prevent the real estate bubble from swelling further. Until late 2009, when the worldwide credit crunch began to abate, it wasn’t possible to do much about the abnormally low interest that made mortgages so attractive and thus fuelled the demand for housing. To the central bank’s credit, though, it was the first to point to the worrisome real estate indicators and to most consistently spotlight them.
In 2010, 35% more mortgages were made available than in 2009, and a whopping 152% more than in 2006.
This, in turn, kicked housing prices skyward, mandating ever-bigger and ever-tempting mortgages.
At the same time our jobless rate, down to 6.1%, allows the bank to be bolder and more aggressive than its overseas counterparts. Inflationary warnings are issued elsewhere, but political constraints and high unemployment discourage the sort of action possible here.
The huge fly in the national ointment is the fact that the widening gap between negligible interest rates overseas and our rising rates means that shekel deposits plainly earn more. This constitutes an irresistible incentive for foreign investors/speculators to buy shekels and dump other currencies.
The upshot is the shekel’s unhealthy appreciation to the distinct disadvantage of Israeli exporters, whose income is continually undercut. This is no minor consideration as this in itself can sabotage the economy, result in plant closures and layoffs and set off a host of growth-busting processes.
Indeed, no sooner was the interest rate raised on Tuesday than the shekel’s value rose. The link between the two is intrinsic.
And that means Fischer will likely have to compensate for his anti-inflationary preference by announcing greater anti-speculation restrictions, as disincentives against supercharging the shekel.