Fischer: Inflation damage to economy 'very serious'

Governor of the Bank of Israel rejects calls for restriction on capital flows.

Stn Fischer good 88 248 (photo credit: Ariel Jerozolimski)
Stn Fischer good 88 248
(photo credit: Ariel Jerozolimski)
Governor of the Bank of Israel Prof. Stanley Fischer said on Thursday that the damage of rising inflation on the economy was very serious but warned that any attempts to restrict capital flows or raise the government's spending ceiling will be very dangerous and irresponsible. "Inflation's damage to the economy is very serious both in terms of attaining long-term growth and high employment, as well as the pain inflicted on weaker classes of the population," said Fischer at the Israel Democracy Institute's annual Caesaria Forum in Eilat on Thursday. In his speech, Fischer slammed proposals by exporters, who have been hit hard by a weakening dollar over the past two years, to restore controls on the foreign currency market in an effort to curb speculation on exchange rates. "Recent suggestions to control capital flows as a way to weaken the strength of the shekel is very dangerous. Such ideas will roll back the local economy to where it was 10 years ago," said Fischer. In opposition to the initiative which attempts to strengthen the dollar and weaken the mighty shekel in the local economy, Fischer said that the example of Chile's use of capital controls and those in Israel in the 1970's and 1980s to curb short-term speculative capital flows already showed that these restrictions did not affect the flow of long-term capital - on the contrary, they probably encouraged inward flows. "The recent sharp appreciation of the shekel was unexpected, and although we have not found any evidence for claims of speculative activity in the exchange rate, it is hard to explain it," said Fischer. Commenting on the repercussions of the global financial crisis on the local economy the Finance Ministry's director-general Yarom Ariav said that there was extreme uncertainty, but clearly the wave will probably hit us eventually and cause a slowdown. "The decision to become integrated into the global economy has greatly limited options for the Israeli economy," said Ariav. On the global economic slowdown, Fischer said that it was possible that the slowdown is already here and it can be assumed that energy and food prices will continue to rise throughout the year. "We will continue and focus on the interest rate to maintain price stability. This is the only way we will able to succeed in getting through the period of slowdown with the least amount of damage, and return to rapid and continued growth," said Fischer. "If we deviate on spending, households, companies, and the government will pay higher interest." Fischer responded to calls by manufacturers and exporters to raise the ceiling on annual government spending to 2.7 percent, from the current 1.7%. "Over the past 4 years, it was the macro-economic approach along with fiscal and monetary policy that brought very successful results," said Fischer. Furthermore, Fischer warned that particularly in a period of uncertainty any change in the government's budgetary targets would send the wrong signals to the investor community. "If we deviate from budgetary targets, we risk losing the confidence of foreign investors and the credibility of local investors," said Fischer. Various discussion sittings at the forum focused on the uncertainty of the magnitude of global financial crisis, the problem of inflation, the exchange rate and the impact of this situation on the local economy. "The slowdown in the growth rate of the economy has raised the level of uncertainty, changed the real interest rate, the price of liquidity and changed the economic environment," said Prof. Daniel Tzidon, head of the Capital Market Unit at Bank Leumi. "The regulation and supervision authorities in Israel have not yet understood the magnitude of the world financial crisis. We need to talk to the authorities around the world to understand how they deal with the situation in an effort to understand how close we are to this uncertainty and how fast it could have a snowball effect onto our economy." Also speaking at the conference, David Brodet, academic director of the Caesaria Forum, said that despite the current financial crisis, the Israeli industry needs to make every effort to move with the world economy, which is shifting to the markets in the east. "Only by being part of the globalization process we will be able to advance the Israeli economy," said Brodet. Bank Hapoalim chief economist Leo Liederman predicted that the country's GDP growth will slow to 4.2% in 2008 and to 3% in 2009. "There is reason to be pessimistic. We expect public consumption and the rate of economic growth to slow down as the public's purchasing power is eroded," said Liederman. Liederman said that inflation will rise to 4% in 2008 from 3.4% in 2007, but predicted that it will fall to 2.5% in 2009, adding that the risk had risen and that the fairly high current inflationary environment will continue in the coming months due to the steady rise in energy prices.