Fischer's dilemma

Our economy might be doing better, yet it remains under the weather. Caution might be best.

By
August 22, 2009 21:51
3 minute read.
Fischer's dilemma

Stanley Fischer 248.88. (photo credit: AP)

It's anybody's bet in the hottest game in town (and also globally): Will Bank of Israel Governor Stanley Fischer raise the key interest rate or won't he? His decision is due tomorrow and it will be one of the most important and riskiest Fischer has had to make, even against the background of the past tempestuous months of worldwide recession. If, as some predict, he will tamper with the current rate (0.5 percent) - the lowest in Israel's history - he'll become the world's first central bank head to trigger the climb back up toward prerecession interest levels. Should Fischer opt for the hike, he will prove himself the bravest of his counterparts anywhere, as none yet dares do what the BOI governor presumably mulls. In itself this might constitute a forceful disincentive for Fischer. Nobody relishes being the first to take the plunge. However, conventional wisdom both here and abroad argues that Israel is best poised to start tightening money supplies (which is what higher interest rates would do, because improved interest-income attracts resources away from financial markets and into bank accounts). By international standards Israel has been least hit by the recent downturn and is likeliest to be among the first to need to worry about inflation versus deflation. Israel never developed the sort of credit bubble that burst elsewhere and hence its resultant credit crunch was less severe. Unprecedentedly low interest rates helped transfuse local financial markets by essentially forcing investments into them for lack of any other income-generating alternative. As such, rock-bottom interest is a monetary stimulus. Yet indications are that our economy may no longer need this sustenance. If that's true, then too much money in the marketplace is liable to spur inflation. According to stats released last week, Israel's economy is thawing out after six months in deep freeze. Moreover, the huge dollar reserves amassed by the BOI to keep the shekel sensibly down - a whopping $52 billion, or $7,500 per capita - in themselves factor in inflationary pressures. Only Japan and Switzerland boast larger per capita hoards. Fischer recently stopped buying more dollars, a fact which is already boosting the shekel to greater unnatural highs. A steeper interest rate will confer on our currency greater advantage yet versus the dollar and will further overvalue the shekel. This is hardly what Fischer wants. Exporters are already suffering from the shekel's distorted strength. Exacerbating the situation will inflict additional hardship and spike joblessness. From the employment vantage, point things indeed are hardly as rosy as growth figures possibly suggest. Jobless numbers don't justify buoyed sentiments. According to latest figures our unemployment rate is 8.4% - a 40% increase in one year. Higher interest rates may raise unemployment to 10% as in 2002, when the economy suffered the twin traumas of a hi-tech crisis and the second intifada. All this encourages the other school of thought to bet that Fischer won't touch interest rates for the fifth consecutive month. While Fischer must remain vigilant against any sign of an inflationary surge, the plummeting dollar exchange rate vis-à-vis the shekel must per force cool his ardor to switch gears on interest levels. Thus far, our annual inflation is 3.6% and analysts predict that by year's end it will touch the 4% mark. Ongoing needs to promote growth, however, entirely contradict anti-inflationary moves and demand a weaker shekel. Fischer is certainly in a bind. There's no denying that the second quarter's 0.25% growth belies forecasts for 0.5% contraction. That is good news. Our recession was shorter-lived than and not as profound as in most countries. Nonetheless the recorded growth margin is minuscule and could be the product of enlarged one-time government expenditures. True, even zero-growth is preferable to recent freefalls, though it hasn't thus far created more jobs, greater income or risk appetite. Higher interest rates cannot be avoided for long, but perhaps this is still not the time. Our economy might be doing better, yet it remains under the weather. Caution might be the best prescription for a while longer.


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