Bank of Israel Governor David Klein is evidently very familiar with the story of the rabbi and the goat. When a Jew complained to his rabbi about how overcrowded his house was, the rabbi recommended that he bring his goat into the house. When the Jew returned and complained that the situation had become unbearable, the rabbi told him to put the goat back in the yard - and the Jew was delighted by how spacious his house now seemed.
That is exactly what the Bank of Israel is doing. Over the last two weeks, the media has been told that the bank believes the situation has changed for the worse: the security situation has deteriorated, the dollar has strengthened against the shekel, long-term interest rates have risen, the budget deficit is too big, the money supply has increased, inflationary expectations have risen and the bank fears a loss of stability.
As a result, the pundits believed that the governor would harden his heart and lower the bank's key lending rate by only 0.3 to 0.4 percentage points. Thus yesterday, when he delivered his big surprise - a cut of 0.5 percentage points - sighs of relief filled the air. The goat was removed, but did relief really arrive?
Not exactly. For a country suffering through a severe recession, a real interest rate of 5 percent (the Bank of Israel's rate minus expected inflation) is too high. Such a rate is suitable for a period of growth, when it is necessary to curb inflation, not for a period of recession. In the United States, which is experiencing a far less severe slowdown, the Federal Reserve Board has kept the interest rate at 1 percent, while the European Central Bank has set its rate at 2 percent. Granted, Israel is neither Europe nor the U.S., but the gaps are still too large. The high interest rate strangles the private sector, reduces economic activity and contributes to unemployment - all unnecessarily, since stability could be achieved even with a lower rate. The negative inflation of recent months proves this.
But David Klein wants maximum security: Even while wearing both suspenders and a belt, he insists on holding his pants up with both hands. Thus he began lowering rates by 0.5 percentage points a month only two months ago. Until then, the reductions were even smaller.
The current problem is where Klein will stop. According to sources at the Bank of Israel, he will bring the interest rate no lower than 6 percent. That scenario terrifies Finance Minister Benjamin Netanyahu, who would like the rate lowered quickly to a level of 4 or 4.5 percent. But he must know that Klein will never do so - even if Aharon Fogel becomes head of the central bank's advisory council and attacks the governor in the media every day.
The truth is that the rate should not be frozen at 6 percent, but should continue to decline in accordance with economic conditions. If inflation remains low, the recession continues and unemployment rises, interest should continue to fall, since that is how one encourages economic activity.
The problem is that over the last few years, the Bank of Israel has specialized in finding excuses for not lowering rates at the necessary pace. Sometimes it blames inflationary expectations, sometimes the exchange rate, sometimes independent forecasts, sometimes bond yields, sometimes the money supply, sometimes the deficit, sometimes the government debt and sometimes the security situation.
It is therefore certain that the bank has other excuses up its sleeve as well. After all, there is no shortage of economists and economic theories. Economics is a forgiving science, in which one can always find a new reason for not lowering interest rates.
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