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In December 2001 Bank of Israel Governor David Klein signed the package deal in which he lowered interest rates by 2 percent, giving the green light to shekel depreciation and the outbreak of inflation in the first half of the year.

Klein thought then that the budget deficit would decrease, private-member legislation would be banned, and Prime Minister Ariel Sharon and Finance Minister Silvan Shalom would introduce a strict deficit regime. He thought then of the classic policy of fiscal reduction juxtaposed with monetary liberalization, but none of that happened.

It became evident to the public very quickly (with the help of the press) that the 2002 deficit would reach as much as 6 percent of GDP, which accelerated the sell-off of bonds and the acquisition of dollars, sending long-term interest rates up, and rapid shekel devaluation let loose the inflationary demon.

Klein has learned the December lesson well and so there was no chance he was going to lower interest rates this time. Once burned, twice very, very careful. First of all, Klein is not sure that last year's story won't repeat itself. Who knows if the Knesset will ratify the budget the cabinet approved? Who knows how the Labor Party will vote, and what amendments may yet be made to the budget?

It is still not clear where the 2002 budget deficit will end up and if next year's deficit will be just 3 percent or if the decrease in tax collection will be worse than the Finance Ministry expects.

In any case, the public votes no. Long-term bonds are being sold off en masse, boosting yields to records of nearly 6 percent on CPI-linked one-year bonds, which proves that the public thinks the government won't meet the deficit target and will need to raise more funds, so higher interest is a requisite. All this is the source of the dropping bond prices and rising yields.

Another clear sign of the lack of public confidence is the continued shekel devaluation despite huge interest rate gaps between the shekel and the dollar. Only someone who expects a sharp depreciation would buy dollars and lose out on such high unlinked shekel interest, and many are buying dollars.

And we still have said nothing about the bank's credit rating downgrade that could lead to Israel's sovereign credit rating dropping too. Nor have we added a word on the war in the territories with no political options and the possibility of war with Iraq.

All these could further damage growth and investments and bore an even bigger hole in the budget, even causing renewed flight of capital abroad, followed by the inevitable shekel devaluation - and inflation.

Therefore, today, when we again hear Finance Ministry voices calling for an interest rate reduction, and manufacturers seeking a "0.3 percent subtraction," the grumblers should be reminded of the lessons of the recent past, of the great fright we suffered in June when the U.S. dollar threatened to overshoot NIS 5 in local currency trade. Because when stability and confidence are lost, it's very hard to get them back.