(photo credit: Ariel Jerozolimski)
Bank of Israel Governor Stanley Fischer has just decided to keep our interest rates at their all-time low. Analysts, though, believe that this may be the last occasion on which he refrains from an increase. His concomitant decision to quit propping up the price of government bonds is regarded as part of a cautious exit strategy from his current recession-oriented policies.
There are good reasons both to change course and not to, and consequently there is no envying Fischer's fundamental dilemma. Like other central bank governors, he's analogous to a tightrope-walker asked to perform his feats of skill in utter darkness. He knows precisely where he should be heading, but can't be completely certain of where to tread en route. A misstep is all too possible, and would be all too catastrophic.
Why the dilemma? On the one hand, leading market indicators point to Israel's very tangible recovery from the global downturn - a recovery seemingly faster and more robust than elsewhere in the West. More rapidly than anywhere else, it appears, Israelis are shedding their risk aversion. The Israeli public, which had fled in panic from any investment - including in ultra-conservative pension funds - is now zestfully back into corporate bonds and equities trading.
The local market is thriving, so much so that there's talk of another dangerous bubble forming. The Bank of Israel's Composite Index is up for the first time since July 2008, and corporate bonds appear to have reversed their massive losses and regained pre-crisis values. This meshes with encouraging overseas indicators.
However, this isn't the full picture. While the fall in production seems abated, the rise in unemployment is not. Indeed, it is headed toward the dreaded 10% mark. Exports were sharply down in 2009's first half, a fact closely interrelated with US unemployment data and the continued slump in real estate there, pointing to reduced American purchasing power and an ongoing downward recessionary pull. This is bad news for Israel's export-reliant economy.
Also harming exports is the dollar's consistent devaluation and the attendant shekel revaluation. This makes Israeli exports less attractive, while severely reducing exporters' incomes. To encourage growth, Fischer presumably must keep shoring up the dollar's value locally by buying up and hoarding the American currency. Were he to raise interest rates, he'd be further strengthening the shekel - the last thing this economy needs right now.
But if he doesn't raise interest rates, he'll exacerbate the reawakening inflationary specter. And any delay in raising rates by small increments now would not only egg on inflation, it would also mandate sharper increases later, which could destabilize the marketplace.
IN ESSENCE two contradictory processes are at play - recessionary and inflationary. The remedy for one exacerbates the other. In recession there's too little money in the marketplace and the objective is to inject cash. In inflation there's a surfeit of capital and the objective is to pull it out of circulation. We are now at the point where both dangers are simultaneously clear, present and potent, and any move is liable to make things worse.
Low interest doesn't only help transfuse financial markets, it also encourages the public to invest in real estate, and the local housing market is already booming, prices are up and the inflationary engine is stoked. Along with this are increased fuel costs and the tendency of wholesalers and retailers to charge the public for tax rises or other increased expenses - and this despite the still-extant overall recession and reduced purchasing power.
But curbing inflation would intensify the credit crunch all over again. A vicious cycle is probable - one way or another. The more we escape recession, the likelier we are to encounter inflation.
THE BOTTOM line: Interest-rate hikes are only a matter of time. Fischer understandably wants to postpone the inevitable, at least until American and European rates are raised, too. Anything else would impose crippling disadvantages on Israel's growth-potential. For now, Fischer needs to settle on an inflationary rate to which he can acquiesce provisionally and which will afford the economy breathing space to improve growth and create more jobs.
To be sure, this quandary isn't exclusively Israeli. And here as elsewhere, what's most important is prudence and circumspection.