Central bank governor David Klein doesn't like surprises. The 4.8 percent cut in nominal rates he announced on Sunday evening was exactly what the market expected - for the last month Klein has been hinting broadly that interest rates would continue to drop, so as to convey a message of stability.

This is only the second time in Israeli history that central bank rates have slipped below 5 percent. It's worth a trip back to the last time - just two years ago.

Klein then flabbergasted the market by slashing interest rates by a whopping 2 percent and within a few months, the market was in financial turmoil. Klein accused the prime minister of being responsible by failing to keep an agreement to cut budgets.

But he knows perfectly well that what is permissible for politicians is not for a central bank governor. The IMF, which usually sticks up for central banks' positions, criticized Klein during its last visit for lowering interest rates too slowly - but did admit their critique had benefit of hindsight.

Today it is clear that the central bank should have reduced interest rates faster - but we should also remember why Klein moved so cautiously. He did not want a replay of the horrible 2002 events when inflation jumped and the shekel imploded. Granted, the chance of a repeat had been small, but the economy would have paid a heavy price if the worst case happened.

That mistake in late 2001, of suddenly lowering interest by 2 percent, set back the entire process of reducing lending rates by two years. This morning, two years later, monetary policy enters a new era - the end of a disinflation process in which the Bank of Israel kept interest rates high to wipe out inflation.

It took ten years, starting from 1993, when Prof. Jacob Frenkel "fell asleep" at the monetary helm and real rates in Israel drooped toward zero. Inflation exploded and in response, Frenkel wildly kicked up real interest rates to 6-7 percent. From till now, except for a few transitory episodes, real rates have hovered at 4-6 percent, with short-term rates sometimes spiking at 10.

Ten years is a long time for a disinflation process. U.S. and European central banks generally managed to stamp out inflation in three to five years. One could blame the protracted process in Israel on its experience of hyper-inflation in the 1980s, or on central bank mistakes. What is certain is that the economy has paid a heavy price for the delay.

As 2004 approaches, so does a great test of the economy. Will the government and central bank manage to move toward Western-style interest rates without destabilizing the economy and prices?

It is a great opportunity for the Israeli economy. Its starting points are very comfortable - global rates are at an all-time low, and American loan guarantees have significantly reduced Israel's risk premium. After ten years of interest rates depressing economic activity, next year they could have the opposite effect for the first time, and stimulate economic activity.

Reducing the domestic lending rates to international standards could render Israel's money markets and monetary policy more sensitive than ever to the international marketplace. Next year the Bank of Israel will have to consider not only domestic macroeconomic conditions, but also the monetary policy of the U.S. Federal Reserve and the European Central Bank, as well as yields on the euro and dollar money markets.

The year 2003 was marked by that easy money handed over by George Bush, in the form of loan guarantees that reversed the bond market, brought down interest rates and pushed stocks sky-high.

Next year could yet be marked by Alan Greenspan's easy money. As long as U.S. funds rates continue to crawl the bottom, they support rate cuts in Israel. Naturally, questions hover over U.S. lending rates after the second half of 2004.

There are also question marks over Bush's fiscal policy. But this morning, let's settle for raising a glass and toasting Klein's 4.8 percent.