Those who kept track of Bank of Israel Governor David Klein's pronouncements over the past two weeks weren't surprised by yesterday's developments. Klein tilled the soil for yesterday's move at a press conference held two weeks ago when he raised interest rates by 1 percent. At the time, he said the economy is not doing well, and if inflation forecasts continue to look bleak, he would raise interest before the end of the month. Subsequently, he sent out the same message on two occasions.
Yesterday, Klein met with top Bank of Israel officials: everyone agreed that the country could not afford to wait any longer - a major move had to be taken to attain the goals of restoring price stability to the economy and of meeting the target annual inflation rate of 3 percent.
Yesterday's decision was motivated by two main considerations - the devaluation of the shekel, and the government budget.
Devaluation: Even after interest rates have been raised in the past, the demand for dollars has continued, and the dollar exchange rate passed the NIS 5 benchmark yesterday. Bank of Israel officials estimated that manufacturers and retailers would not be able to put up with a further devaluation of the shekel and would raise prices, thereby pushing the annual inflation rate well past the sought-after target figure.
Klein knows that he has little hope of meeting inflation targets in 2002, but he is unwilling to give up on 2003. So he decided to raise interest rates so that the dollar exchange rate would not continue to rise until the end of the month.
Budget: The second issue which compelled the governor to raise interest rates involves the state budget. Klein is not thrilled about the government's emergency recovery plan; he believes that it features too many taxes, which will raise prices, and that it proposes insufficient cuts in government expenditure. Klein also doubts that this is the year's final government economic plan; although government officials claim the plan will remain in effect until 2003, Klein believes it will last no longer than three to four months.
Klein doubts that the government deficit this year will be "just" 4 percent. He is worried that interest rates will continue to rise in the long term, so he feels compelled to increase them in the short term as well.
Israel's economy is not out of the woods. The public remains influenced by increases in interest rates and by stringent handling of the government budget. The keys to economic stability are now held by two persons who loath one another - David Klein controls matters with respect to interest rates, while Finance Minister Silvan Shalom controls the budget. Whether stability and growth are to come depends on them.
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