After senior staffers at the Finance Ministry accused the Bank of Israel of lacking transparency, governor David Klein taught them exactly what transparency is. This week he invited the press to be present at the central bank's monetary committee that decides on next month's interest rate. The show was beautifully presented, but it was clear that the real discussion will be held next Monday morning far from prying eyes. The same afternoon Klein will announce his interest rate decision.
Once, when Klein was head of the monetary department at the bank, he symbolized the far-right (in monetary terms). He, and the department, would always support raising the interest rates or at least not lowering them. The research department (whether headed by Avi Ben Bassat or Liora Meridor) would always favor cutting the rate, to pave the way for growth and employment. And Jacob Frenkel (then governor) would always find the middle way.
Plus ca change, plus c'est la meme chose. Now Meir Sokoler, head of the monetary department, is the one to present the worst case scenario: Inflation of 5 percent in 2001 and 11 percent in 2003 - if the interest rate is not raised by 0.5 percent in the next six months. A frightening thought.
However, the monetary department was forced to admit that inflation forecasts are falling and this year's CPI is expected to rise by only 2.5 percent, but according to "the model" the future is far bleaker.
What is this "model"? This is the econometric model that apparently Klein uses to calculate the required interest rate in the economy. The major variables of the model are: capital flows and their effect on the exchange rate, the gap between expected rate of growth (4-5 percent) and actual growth achieved (currently 1 percent), and size of the government budget deficit (3 percent of gross domestic product).
But as I know Klein, he doesn't really trust these models, and there is little connection between these models and reality. There was the time when the Bank of Israel set the interest rate according to expected inflation or the U.S. interest rate, or analysts' forecast - whatever the fashion at the time was - but nowadays everything is set by the "model."
If I were a suspicious guy, I would suggest that Klein and Sokoler prepared a little script beforehand, with Sokoler playing the "nasty cop" and instead of calling for a cut in the interest rate, as Finance Minister Silvan Shalom expects, he would call for a raise in the interest. Then come Monday afternoon, Klein will announce he is leaving the rate of borrowing unchanged - and we all applaud because he has stood up to "the model."
But whatever happens, Klein ought to know that the economy is waiting for a cut in the interest rate, and for no other exercise. Admittedly the interest rate is not the wonder drug for growth (see Japan) but it is the millstone around the private sector's neck. According to the depth of the economic downturn, it should be clear that inflation targets could still be achieved for next year even if November's interest rate was cut to 6 percent come next Monday.
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