A tale of two central bankers

Fischer's job is an easier one than Bank of England's King.

fischer london 88 224 (photo credit: Bloomberg)
fischer london 88 224
(photo credit: Bloomberg)
As he stepped out of the Threadneedle Street sunshine into the lofty central hall of the Bank of England last week, Bank of Israel Governor, Professor Stanley Fischer, could have been forgiven for feeling just a little smug. Fischer had popped in to see his old friend and opposite number, Prof. Mervyn King, having earlier delivered a cautious but relatively sanguine assessment of Israel's economic outlook to a City of London audience during his visit last week to the Israel Opportunity Conference 2008 jointly organized by the London and Tel Aviv stock exchanges. Fischer is not a man known for taking his responsibilities lightly, but compared to the problems besetting King, his must seem like a bed of roses. The two governors have many things in common: a strong association with the London School of Economics, careers spanning both academia and policy making, and a "hawkish" outlook on inflation. Both are relatively new to their current jobs, King having been appointed to his post five years ago, and Fischer to his three years ago. There was almost certainly a lot the two could agree on. Israel, like Britain, is grappling with the problem of rising inflation, brought on by soaring oil and commodity prices, and the rising cost of food. The aim of both governors is to prevent soaring prices becoming endemic through their impact on inflationary expectations. To that end, they have signalled their willingness to raise interest rates. This is already happening in Israel. The official base lending rate rose for the second time in two months in July, taking it to 3.75 percent from an all-time low of 3.25% in May. It may have to rise further. As the price of oil hit a record of over $140 a barrel at the end of last week, sparking panic conditions in stock markets around the world, Fischer acknowledged that he, like other central bankers, is at the mercy of events. "Oil prices are the joker in the pack," he told delegates at the Israel Opportunity 2008 Conference in London last week. For all that, his problems pale in significance when set against those faced by his counterpart in the UK. The Bank of England may want to raise rates to contain inflation but has its hands tied by the dire state of financial markets and the wider economy. The housing market is collapsing, banks are facing billion dollar write-offs, credit markets have seized up and retailers are reporting dire conditions in the shops. There has been talk in Britain of a return to the "stagflation" of the 1970s, when a lethal mix of soaring inflation and falling output brought the country to its knees. Such fears are exaggerated, but there is no denying that the British economy faces a difficult period. The Consumer Price Index hit 3.3% at the last count in May against a target of 2% and is forecast to reach 4% or more later this year as price increases already in the pipeline work their way through. Other, wider measures of inflation suggest that 4% plus inflation is already here. The bank admits that it faces its greatest challenge since being granted independence in 1997. As the credit crisis threatened to spin out of control in April, it cut interest rates from 5.25% to 5% while at the same time pumping huge sums of money into the banking system. But credit remains scarce and those forced to borrow on the interbank market are having to pay 6% for three month money, a hefty premium over the official rate. City experts believe that King will be forced to raise rates later this year, but if he does the downside risks to the financial system and the wider economy will be considerable. No such dilemma faces Fischer. Israel's banking system is in good shape. It is well capitalized, has a wide spread of business, few bad debts and - most remarkable of all - virtually no sub-prime loans to worry about. This was confirmed by Bank Leumi President Galia Maor at the Israel 2008 Conference. She admitted that the bank did discuss the possibility of buying into the sub-prime market but had decided against it. "We did not change our long established conservative policies," she told delegates. "While banks around the world are having to go back to basics, we have always remained focused on the basics." Unlike his British opposite number, Fischer has ample room for maneuver. The British consumer boom of the past decade has been accompanied by a dramatic deterioration in the current account of the balance of payments. By contrast, growth in Israel has been led by manufacturing and exports and the current account has been in substantial surplus in recent years. That surplus is set to shrink and even disappear as a strong shekel and deteriorating conditions in key markets like America take their toll on exports and as Israeli consumers use their new found spending power to buy foreign goods and take holidays abroad. Fischer is sanguine. Israeli exports are diversified and have a high skills content, making them less vulnerable to the effects of changing world circumstances. Furthermore Israeli companies have shown themselves to be highly adaptable, seeking out new markets in Asia while old ones shrink. "The truth is that we could live with a small deficit," he told his London audience. Fischer is also confident that the government will stick to the policy of fiscal restraint which together with the Netanyahu reforms of 2003 has played a crucial part in the transformation of the economy. The government has delivered a constant level of deficit spending of around 1.5% of gross domestic product, has paid off some of the enormous overhang of debt and has slowly reduced the size of the state apparatus in the overall economy. Despite enormous pressures to step up spending in what could be an election year, Fischer believes there will be little slippage. By contrast, the British government faces the prospect of recession with depleted coffers and a large budget deficit after a spending spree which has devoured the benefits of rapid growth and record tax revenues. The Israeli economy is expected to maintain its forward momentum while other advanced economies move into neutral or reverse and many emerging economies move from boom to bust. That is no mean achievement. As he shook hands with King and said his good-byes, Fischer must have heaved a sigh of relief.