Middle Israel: Karnit Flug, our very own Janet Yellen

Flug was the economic week’s heroine, but the soft spoken economist evidently lacks heroic pretensions, and can be expected to maintain a low profile as long as external events don’t suck her into politics.

Karnit Flug 370 (photo credit: REUTERS)
Karnit Flug 370
(photo credit: REUTERS)
‘A heroine,” said Mark Twain, “would be great to live with – in a book.” If any of the Bank of Israel’s 700 employees share this sexist concern, they can relax, despite Karnit Flug’s operatic emergence this week as the improbable winner in the bizarre race for the central bank’s governorship – a race which Flug never formally joined.
Flug was the economic week’s heroine, but the soft spoken economist from Jerusalem evidently lacks heroic pretensions, and can be expected to maintain a low profile as long as external events don’t suck her into the greater political fray.
Then again, global, regional and local dynamics can be counted on to test Flug sooner rather than later, as she enters Stanley Fischer’s big shoes while taking stock of an economy beset by fiscal and monetary dilemmas as well as market paradoxes and social gaps.
WITH IMPECCABLE scholastic credentials, including a cum laude master’s in economics from the Hebrew University and a PhD from Columbia University, no one has questioned the intellectual ability of the woman who had previously served as Fischer’s deputy, an International Monetary Fund executive and a senior economist in the Washington-based Inter-American Development Bank.
Even so, Flug never made it to the candidates’ pageant that produced the farce of a four-month limbo animated by one nominee’s resignation amid an unsubstantiated shoplifting tale, and another’s amid stories concerning astrological audiences.
Evidently taken aback by their repeated failures to fill the vacancy, Prime Minister Binyamin Netanyahu and Finance Minister Yair Lapid seemed unable to agree on a candidate. Reportedly, Lapid wanted Flug from the outset, but Netanyahu preferred to seek a big name, someone who would emulate Fischer’s monetary heroism.
Justly proud to have appointed Fischer in the last decade, a choice that caught everyone off-guard and proved to be a stroke of brilliance, Netanyahu wanted to repeat that act. That is how he reportedly arrived at Israel Prize laureate Elhanan Helpman, originally of Tel Aviv University and currently a Harvard economist who previously served as a member of the Bank of Israel’s advisory board, clearly a worthy candidate. The only problem was that Helpman was not interested.
Only after Netanyahu failed in a last-ditch effort to recruit another hero, former US treasury secretary Lawrence Summers, did the prime minister give up on the heroic option, resigned to the anti-heroic Flug. It was a process intriguingly similar to the one that this month crowned Janet Yellen as Ben Bernanke’s successor.
In itself, this is not necessarily bad. Since prime minister Ariel Sharon’s political departure, Israel has generally entered a post-heroic age that began in the military, where generals became more humble and media shy, while remaining no less professional than their predecessors. There is some of this zeitgeist in the passage to Flug from Fischer, and before that Jacob Frenkel.
Then again, the arduous road to her appointment left a bad aftertaste in the corridors of power and beyond. The good news is that such a delay happened before, in 1999, when Ehud Barak took two months to choose Frenkel’s successor. The bad news is that the precedent was not good.
That governor, David Klein, while a brilliant economist, lacked his predecessor’s charisma. He was ultimately arm-twisted by then-finance minister Silvan Shalom, who demanded and obtained a sharp interest rate cut – which soon afterward had to be reserved after the shekel plunged to a historic low of five-to-the-dollar.
Such dynamics are not likely to transpire between Flug and the political duo she faces. Netanyahu and Lapid believe in a strong shekel and in the central bank’s independence. However, Flug’s is a five-year term, an eternity in Israeli politics. Fischer, for instance, faced five finance ministers. The question, therefore, is how Flug will fare when faced, say, with a finance minister from Labor who will be eager to tax and spend.
In fact, this happened even with the conservative Netanyahu, who in 2011 responded to the social justice protests by breaching the budget deficit, despite Fischer’s protestations, which were indeed vindicated when a NIS 40 billion budget deficit demanded this year’s sharp cuts.
FLUG’S FIRST task, regardless of circumstances, is to maintain price stability and a strong currency.
Price stability for now seems relatively easy to deliver.
With inflation currently at an annualized 1.2 percent, prices are in line with the norm in other mature economies and well within the government’s target.
The shekel is a different story. Having appreciated by 12% since trading last fall at four-to-the-dollar, the shekel is becoming excessively strong from the viewpoint of Israeli exporters, who earn in dollars and euros, but pay salaries in shekels. This is particularly damaging for economies like that of Israel’s, or Japan and Taiwan, which are dominated by their exports.
The Bank of Israel’s conventional weapon in such a case is the interest rate, which in such circumstances would ordinarily be cut, thus making it less attractive for investors. This in turn would lower its demand and therefore also its price, or exchange rate. However, the central bank’s key lending rate is already low, 1%, a mere 50 basis points from its historic low of 0.5% back in ’09, following the global meltdown.
Moreover, lowering rates would stoke the fires of an already overheated housing market, where prices have soared over the past six years by 72%, making an average three-bedroom apartment’s mortgage take 135 average salaries to pay back. Now the market is so overheated that judging by the rate of mortgage borrowing during the first three quarters, the year will end with overall annual mortgage borrowing exceeding NIS 50b., thus breaking 2010’s record of NIS 48.6b.
Lower interest rates make mortgages seem cheaper, and therefore boost mortgage borrowing. It follows that between its quest to help exporters and its need to cool the housing market, the central bank faces contradictory aims.
Fischer bypassed this constraint by launching massive dollar purchases, totaling $52b. over five years, thus artificially raising the greenback’s price and lowering the shekel’s, at a time when lowering interest rates became difficult.
Flug is expected to continue this policy. What’s more, she faces an additional challenge in the wake of Israel’s gas production. The Bank of Israel has already announced that in 2014, it will purchase $3.5b. in order to offset the effect of prospective foreign currency inflows from the newly exporting Tamar field.
SUCH, THEN, are the kinds of market dilemmas Flug will face. But her most daunting challenges will be in the confrontations she might be drawn to with market players.
Alongside the negative precedent of Klein’s encounter with politicians, are the positive precedents of Fischer’s clash with bankers, and Frenkel’s with industrialists.
Frenkel spent much of his nine years in office battling a business sector that demanded drastically reduced interest rates. Frenkel thought otherwise, never giving in to the pressures, and ultimately reduced inflation from double-digit levels to nearly zero. At one point he also clashed with then-finance minister Dan Meridor over foreign exchange policy, and the clash ended with Frenkel’s victory and Meridor’s resignation.
Fischer, upon learning of Bank Hapoalim chairman Danny Dankner’s misguided management, demanded and obtained Dankner’s removal. It was a display of regulatory leadership and resolve that Israel had never seen, even in Frenkel’s tenure.
Whether Flug will manage to wield such authority over the business sector in general, and the banks in particular, will largely decide her governorship’s success.
Israel’s banking sector suffers from a lack of competition and a shortage of players.
Fischer’s narrowing and capping of the banks’ elaborate and exorbitant commissions was but the beginning of a transition that should be much broader.
Israel’s financial industry is dominated by five banks.
The US had 25 banks in 1800, when its population was just over 5 million people. In other words, the commissions we pay are but a symptom of an industry that has too few banks with too many employees and salaries that are too high.
If Flug manages to change any of this, the middle class will surely be grateful, as such reforms will reduce the excessive banking costs every Israeli household shoulders for no justifiable reason.
Critics fear Flug will be a monetary dove who will tolerate expanded government spending. Then again, she is on record for advocating raising women’s retirement age, a conservative position that is disagreeable to some women’s organizations. Where she will stand, and how prepared she will be to fight on issues like income gaps between the rich and poor, senior executives’ pay or social spending remains to be seen.
What is clear already is that the middle class and its travails are well-known to Flug, for the prosaic reason that she never traveled too far from it.
A mother of two, wife of Hebrew University economist Saul Lach, and daughter of Holocaust survivors, the 58-year-old Flug lives in a middle class apartment building in Jerusalem’s Beit Hakerem neighborhood.
It is within walking distance from the Givat Ram campus where she earned her BA and MA, and where she also went to high school at the Hebrew University Secondary School – a three-minute walk from the Bank of Israel that she now heads.
Hopefully, the visibility of all these from her new office will make Flug complement with compassion the professionalism all agree she has, and compensate with passion for the charisma some feel she lacks.www.middleisrael.net