Bottom shekel / Israel finds it can't escape deflation either
The consumer price index eased down by 0.1% in February. It was the fourth straight month in which prices fell: the CPI fell 0.6% in November, 0.1% in December and 0.5% in January. In that time, in short, the index fell by 1.3%. That is a worrisome figure.
Prices are likely to fall further in the months to come. Inflation forecasts for the year range from zero to -0.5%. Like the developed world, Israel is suffering from deflation.
The public has been hit by recession both here and abroad. The result has been layoffs, wage cuts, budget cuts and a loss of wealth. Uncertainty about the future is worse than usual, so people are cutting back on nonessential purchases, and sometimes even on essential ones.
Prices have been slumping around the world for raw materials, foodstuffs and energy. It wasn't that long ago that oil was approaching $150 a barrel. Yesterday it closed just above $47.
Investors know how to cope with inflation, but are much less prepared for deflation. What can be done with warehouses full of merchandise and goods no one wants to buy? The leaders of Israel's economy are also no mavens at handling a deflationary economy.
Thanks to the lower February CPI, Bank of Israel Governor Stanley Fischer will be able to reduce interest rates by a further 0.25%, to 0.5%. Still, there's not much difference between 0.75% and 0.5%.
Bank of Israel officials are undecided about new tools that would help the bank control monetary policy while deflation reigns. The tool currently in question is the purchase of corporate bonds. These have many advantages, but also risks, and the central bank is in no hurry to take the plunge.
All over the world countries are trying to cope with the financial crisis, so central banks are busy with monetary decisions and the finance ministries are sweating fiscal policy. In the past few months, however, Israel's fiscal policies have been frozen. The formation of a new government in the coming weeks, followed by the approval of a new economic policy, will provide new momentum.
An important aspect of the renewed momentum will be how we cope with deflation.
One thing is certain: An extended period of price falls could have painful effects on state revenues from taxes. And without revenues, the government will have no money for spending.