Bank of Israel senior adviser Topf: Israel must have a moral economy

Israel’s economy needs strong moral underpinnings to blossom and become more equal, according to BoI adviser.

Bank of Israel 370 (photo credit: Wikimedia Commons)
Bank of Israel 370
(photo credit: Wikimedia Commons)
Israel’s economy needs strong moral underpinnings to blossom and become more equal, according the Bank of Israel’s Barry Topf, who is stepping down from his position as senior adviser to the governor on monetary policy issues and member of the Monetary Committee at at the end of October after 32 years on the job.
Asked what important issues Israel’s economy faces, Topf responded: “The moral underpinnings of a well-functioning economy... Corruption or its perception can have an effect on performance, and I think these shouldn’t be taken for granted.”
Similarly, a moral approach to business could help reduce inequality, he said, adding: “I don’t think that’s a legal and or economic issue; that’s an issue of norms and appropriate behavior. That’s where people should look for the solution, not to legal or policy steps. Even if managers and owners have the ability to extract a certain return from their business legally and financially and economically, I think they have a duty to ensure that it’s appropriate and proportional to their own contribution and the contribution of others.”
The Bronx-born Topf, who made aliya at the age of 21, recently sat down with The Jerusalem Post at the Bank of Israel to discuss his experience at the bank.
Topf’s departure comes at a time of transition. The six-person Monetary Committee that makes the central bank’s key interest-rate decisions, which includes three bank representatives and three outside academics, has been short one person since former Bank of Israel governor Stanley Fischer stepped down at the end of June. Karnit Flug, Fischer’s deputy and the current acting governor, plans on stepping down shortly after a new governor is in place. Topf’s departure means the central bank’s entire representation on the committee will be new.
While he refused to comment on the prolonged search for a new governor or the performance of Finance Minister Yair Lapid, Topf offered insights into how Israel navigated the 2008 financial crisis, the qualities the next governor should have and the why markets are like Polish mothers.
What has been your most important accomplishment to date at the bank?
Helping steer the central bank during the economic crisis, which began in 2008, without a doubt. The bank’s response was particularly important here because there was a transitional government, so fiscal policy, the other lever of macroeconomic policy, was not available to be used.
The most important thing heading into a crisis is having a strong, resilient economy, and that you can’t do once the crisis hits.
Probably the single-most interesting thing we did, and to my mind still had the best positive impact, was intervening in the foreignexchange market starting in March 2008, which I think played a major role in helping the small, very open, export-oriented economy to deal with an almost unprecedented global crisis.
Along with that, we also increased our foreign-exchange reserves, which we had wanted to do for a long time. The higher foreign reserves are an insurance policy, improve our credit standing and give flexibility to respond to a crisis should one develop. In that sense, the increase in reserves during my tenure is one way I know I leave the economy in a much better condition than when I began, or even five years ago.
The unsung hero of the crisis was the fact that we responded very quickly in terms of liquidity to the banking systems, which helped the Israeli banking system avoid problems. It kept functioning.
The fact that a year before that we joined the CLS [international clearing system], so foreign exchange transactions were able to continue with high level of certainty.
Quantitative expansion, which was not called that at the time, initiated in February 2009, also boosted the economy. And of course, all along, similar steps, strong steps in banking supervision were very important. And the monetary policy response of lowering interest rates at a timely, sometimes dramatic fashion.

What is your greatest regret?
I would’ve wanted to have more of an impact in terms of promoting long-term reforms in the Israeli economy, which working on the financial side I really didn’t. I would have personally been gratified to play a role in long-term structural reforms, which is needed in education, health care, infrastructure.
There’s a lot of work that still needs to be done in infrastructure – transport, telecommunications, ports.
These are all in the news all the time.
In terms of education, if you look at long-term health, it’s based on quality of the education system, and a lot has to be done there. I think the health-care system, while good, faces major challenges.

Fischer won accolades for his performance as governor. You were his adviser. What made him exceptional?
He brought a standing and self confidence and gravitas that allowed him to take dramatic decisions in a timely fashion, such as the intervention in the foreign-exchange markets and reducing interest rates. He really saw the big picture and was willing to be flexible, and in a certain way even unconventional, and respond to the needs of the moment.

Any stories that stick out?
There’s the classic story of him serially pulling me off planes at various points in the crisis. He delayed an El Al plane on the way to New York – that was two or three days after Lehman Brothers – on the way to the IMF meetings, and he decided that we both have to stay because of the crisis. I was already on the plane and it was about to pull away, and I get this phone call. And they don’t let you off the plane for security reasons, so I stand up and everybody jumps, and the security officer asks to speak on the phone, and he gets on and says, “Shalom zeh Stanley Fischer,” so they let me off.
With Fischer gone, and you and Flug leaving, there will be an obvious hole in the Monetary Committee.

Will markets worry about that?
The markets can be like a Polish mother: They worry about everything, but that doesn’t mean it makes anything better. I rely on the people who make those decisions to appoint capable and able people to fill all those rolls, so there will be continuity. I think it’s a mistake to ascribe too much importance to personalities.
On the one hand, the quality of the work always comes down to the people, the human element, especially in the area we work in. On the other hand, there’s a reality: There are talents and capabilities that are not spread equally amongst everyone, but they are certainly adequate at the top levels of the bank and the economic field in Israel.
The structure, the very fact there is a Monetary Committee and the three outside members are staying creates continuity. I don’t think it’s a concern for the markets. The bank has shown over long periods of time and through a lot of personnel changes that it’s a competent and well-managed institution with a lot of talent, and I wouldn’t ascribe too much importance to personnel changes.
Of course it would be preferable to have positions filled in a timely, efficient manner. But we’re not the only institution in Israel or in the world in which these kind of decisions take time.
What are the most important qualities they look for in a central bank governor?
Humility. The physicians’ motto is do no harm. People in the central bank have an influential role; we have to be very responsible, very careful, very humble to a certain extent. There are limits on what we can do. We’ve seen a lot of mistakes that have stemmed from overconfidence.
He has to be a good manager, because this is an organization with tremendous potential. We have a lot of talented people, but talented people can be harder to manage.
We need someone who is able to think deeply and see the big picture, but maintain a degree of flexibility and not be hemmed in by the conventions, which in the financial world can be strong.
It’s extremely important that it’s someone who can control the independence of the central bank and high ethical standards. We sit here on a lot of money, a lot of power, and that comes with temptations, and the bank has always maintained a high standard of behavior.

Is there a specific philosophy or worldview a governor should have?
I don’t think there’s a point in making too much of whether this person is a monetarist or that person is a Keynesian. Since 2008, everyone has to be a pragmatist. The Chinese leader Deng [Xiaoping] said he it doesn’t matter what color the cat is as long as it catches mice.
The shekel appears to just keep strengthening, but BoI interventions have moderated it. What’s the right balance between market forces and intervention?
Given the current world monetary setup, it’s extremely difficult to resist very fundamental long-term market forces. What we try to do is strike a balance between allowing long-term forces coming in to play while taking the edge off in terms of the damage that large and unjustified deviations can cause.
Unlike financial markets, the real economy has a memory, in the sense that if a currency is overvalued for too long, contracts are missed, markets are lost, production lines are shut, or in the worst case, employees are dismissed. Once the currency returns to its true value, those effects remain, because there is overhead, there’s tremendous lag. You don’t immediately get a contract back, you don’t immediately move a production line back from overseas, so we try to strike a balance between allowing market forces to come into play, leaning against the wind when the deviations are very large and clearly unjustified.
What would you say are the most pressing issues Israel’s economy faces today?
You always have the problem of letting the urgent delay the important.
The immediate items on the table include dealing with the slowdown in the international economy, especially international trade. Exporting is the key to the performance of this economy, highly dependent on international trade, dealing with the spillover of the monetary policies of advanced economies, including the exchange rates, which aggravates the previous problem.
It’s important to mention the areas we don’t have problems, so evident in the rest of the world. For example, financial stability. People take it for granted, but it’s the result of years for hard work on the part of the regulators, on the part of the institutions themselves. And you have to throw in a good word for the economy itself. People keep talking about the Ministry of Finance, the Bank of Israel. But we talk about how we got through the crisis, how we got through the crisis was with an economy that functions well – productive private sector, productive workers, managers, exporters, the hi-tech sector.
They deserve the lion’s share of the credit.
For the most part, we can manage to help and constantly ensure we don’t make things worse. We can provide a good environment. Which brings me to the important but less urgent things. One of them is increasing productivity of Israeli workers, which is still low compared to other economies. The demographic challenges we’re facing in terms of participation in the workforce.
Health, education, which is the key, and this country of all countries should make a tremendous effort there.
And I would add something: The moral underpinnings of a wellfunctioning economy – lack of corruption, enforcement of laws – and unfortunately we’ve seen some backsliding. It’s not just a matter of judgement. There are surveys from places like Transparency International that rate it, and corruption or its perception can have an effect on performance, and I think these shouldn’t be taken for granted.
How can Israel increase its lagging worker productivity?
From a macro perspective, the capital per worker here is fairly low. In the hi-tech sector we create solutions to help productivity everywhere else in the world, but we’re less advanced in using them and applying them here.
We should be the first guys off the block in terms of digital revolution, in terms of fiber-optical and a totally wired or wireless economy. Educational system, we mentioned, work, lack of professional and vocational training – there are bottlenecks in certain areas.
Red tape, bureaucracy and labor market has become much more flexible, but there are still a lot of factors inhibiting that, like lack of rental housing. Workers place a higher priority on being at a job near a purchased home. There are a lot of factors, even though it’s a dynamic economy, that keep the economy hidebound.
The liquidity at the Tel Aviv Stock Exchange is down and both its CEO and chairman have resigned. What needs to happen to revitalize it?
It’s obviously in everyone’s interest to have an adequately liquid and functional capital market, but that’s in my mind primarily a function of the underlying economy and financial system. Specific steps can always be taken to heighten liquidity, but the problem is a global one, and I don’t see it as a crisis by any means.
Some experts think Tel Aviv should be a financial center like London or New York. Is that something you think is desirable and possible?
No. As far as I know, every country in the world from Grenada to Fiji to Trinidad and Tobago has at one time or another decided that they want to become an international financial center.
The requirements for being an international financial center are very specific. There are very few of them, and the international financial world is becoming more concentrated rather than less concentrated. It would be very nice, but you just don’t have the conditions here – be them population, be them market size, be them geopolitical position – that you need to become an international financial center.
That being said, where we could excel is in supplying services to the international financial industry in the area of technology, in the area of expertise, in the area of economic modeling. But those are very specific; given the size of Israel’s economy we would be a niche player.
What is the source of Israel’s income inequality? What’s the solution?
It’s easy to say that income inequality is an unpleasant phenomenon.
Beyond that a lot of studies show it has a deleterious effect on economic performance, so it’s not just equity or fairness. The sources – there’s considerable debate in the profession what they are, but we’re looking at something that’s a global phenomenon. I don’t know if there’s anything specific to Israel other than the factors operating here sometimes have different weight. For example, we are more heavily involved in areas with increased returns to high-end talent, such as tech or R&D, so it is more pronounced in Israel.
So is the solution to get more people into those sectors?
Obviously we’d like to increase the size of the cake, not just the way it’s divided. A rising tide raises all boats.
We’d like to see the gap close by bringing the lower end up, not just pressing the upper end.
Speaking personally, not as a central- bank economist, I think you can’t look to policy makers to solve all issues. Some of them are ethical and behavioral. If you ask me if there’s been a problem with the incentives in the economy, I would say yes. But I don’t think that’s a legal and or economic issue; that’s an issue of norms and appropriate behavior.
That’s where people should look for the solution, not to legal or policy steps.
Even if managers and owners have the ability to extract a certain return from their business legally and financially and economically, I think they have a duty to ensure that it’s appropriate and proportional to their own contribution and the contribution of others.

The US seems in danger of hitting its debt ceiling. Should Israel be worried?
If America defaults on its debts, it would be worse than the crisis we experienced a few years ago. But I don’t think that’s possible. We can throw in the Winston Churchill quote about how America always does what’s right, but only after exhausting all other possibilities.
After a long tenure in the job, what message would you want the public to know about the economy or your work specifically? I think people should pay less attention to headlines. I think there’s been a drift towards overemphasizing the public relations and headline quality of decisions at the cost of a more fundamental analysis of dealing with the problems. There’s been a tremendous compression in attention spans. Economic performance by definition transpires over different period of time. People are too focused on the short term. I think people have to pay attention to the moral and ethical aspects of their behavior.