Officials at the central bank certainly don't like the fact that most of their ammunition has run out because of the recent series of interest rate cuts. That is why they have sent up a new trial balloon: The Bank of Israel will buy up government and corporate bonds, and thereby manage to influence long-term interest rates.
The Bank of Israel's regular monthly interest rate decision applies only to short-term rates, including those for overdrafts and short-term business credit, for example. Long-term rates are set in the market for corporate and government bonds.
Usually there is a link between short- and long-term interest rates, and when governor Stanley Fischer lowers short-term rates, this also affects the long-term market. But long-term rates are influenced by many other factors, including government spending funded by issuing government bonds, and of course the economic situation.
This year the state will have to increase the amount it raises in bond issues because of the anticipated higher budget deficit, which is likely to give rise to higher long-term interest rates - something directly opposed to Fischer's own policies and actions to lower rates.
In such a situation, the central bank is forced to deal not only with a lack of ammunition, as interest rates have now fallen to only 1% and there is very little room left to lower them any further; but also with the government's actions, which will have the exact opposite effect. The result, as far as the private sector is concerned, is higher interest and higher financing costs for long-term credit. The price will be the collapse of even more companies, more layoffs and a halt to investment. In such a scenario, it becomes impossible to talk about returning to economic growth anytime soon.
That is the reason why the bank is now examining a number of creative options, including buying up corporate and government bonds, in order to lower long-term interest rates.
When Fischer decided in the past to buy dollars and help exporters by propping up the dollar, many were surprised and opposed to his aggressive intervention in the free market - but Fischer succeeded and since then the dollar has risen from NIS 3.23 to approximately NIS 4 today.
Buying government bonds could be a reasonable and legitimate solution under the present circumstances, but buying corporate bonds could put the Bank of Israel smack in the middle of a minefield. Such a move could put Fischer into the precarious position of having to decide which firms and tycoons survive, and which don't.
Fischer is playing a dangerous game, not only as governor but as the one who will decide who will and who will not survive the coming year. At least as far as corporate bonds are concerned, I hope he will make do with signaling the markets that he is willing to buy, which is often good enough - without actually having to use this weapon.
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