The Finance Ministry and the Bank of Israel will soon begin talks on the best way to abolish the currency fluctuation band. The treasury will surely demand that in return for getting rid of the band, the central bank should cut nominal interest.
It is wrong to believe that the band, which sets the limits that the exchange rate cannot cross, produces certainty. In reality the band increases uncertainty, because it enables speculators to gamble against the Bank of Israel whenever the currency nears the limit.
Furthermore, it gives exporters no security at all, because the central bank's reserves are limited and when the moment of truth arrived, it would not be able to sell enough to meet public demand and the band would inevitably be revoked in a time of crisis.
It's high time to abolish the 12-year-old band - it was suitable only for a transition period between a fixed and free exchange rate. Dan Meridor stepped down as finance minister after only one year in office over the expansion of the band. Meridor was wrong at the time to oppose the expansion; Jacob Frenkel and Benjamin Netanyahu were right.
A free exchange rate is indicative of economic strength, the confidence of the leadership, and a responsible policy to reduce the budget deficit - since any crisis will immediately push the exchange rate up.
A free exchange rate is therefore a tool to discipline politicians. It reduces the drain on foreign currency, and prevents financial crises like those we witnessed in Russia or Argentina, where they thought they could artificially maintain a low exchange rate.
Therefore, there is no need for negotiations between Netanyahu and the central bank. No conditions should be stipulated - the fluctuation band should simply be done away with, once and forever.
While he's at it, Netanyahu should also dump the bill proposed by his predecessor, Silvan Shalom, to govern the Bank of Israel. This law could potentially eliminate the central bank's independence and shatter economic stability. These two moves would bring Netanyahu good PR benefits and at the same time make it easier for the Bank of Israel to cut nominal interest, because they would stabilize the economy.
At the same time, governor David Klein must not sign any deal with the treasury. We can only hope Klein learned his lesson from the December 2001 fiasco, when he signed a deal with Silvan Shalom and Ariel Sharon. Shalom and Sharon were to slash the budget, maintain a low deficit and allow the central bank to issue treasury bills (makam), while Klein was to slash the interest rate by 2 percent in one go. This mistake has haunted Klein ever since.
When Netanyahu gets the entire plan for budget cuts approved by the Knesset, when we are satisfied that the deficit is actually reduced, when we see long-term interest rates dropping - then and only then can the Bank of Israel cut interest rates.
To keep in mind the trauma of June 2002, we should practice repeating: "Once bitten, twice shy."
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