First Lower the Interest Rate

Has Klein surrendered to the sharp criticism directed at him from every quarter? Can we expect to wake up one morning to a 1-2 percent reduction in interest rates?

On Tuesday, the armor that Bank of Israel Governor David Klein wears seemed to be showing a few cracks. He told all the mass media that he was prepared to lower interest rates by one whole level as part of the economic package plan that was being formulated.

"If circumstances that warrant a readjustment of the interest rate to a lower level develop," he said, "we will do so as a one-time measure."

Has Klein surrendered to the sharp criticism directed at him from every quarter? Can we expect to wake up one morning in the near future to a 1-2 percent reduction in interest rates, all at once, as should have been the case a long time ago?

Don't count on it. One has to listen to everything that Klein says. He has a whole list of conditions and restrictions. He speaks in general about the situation in which a sharp reduction in interest rates will not boost inflation, about the expansion of the money market and about additional liberalization in the foreign currency market. It all sounds so nice and innocent, but there are many traps.

Klein wants, for example, to cancel the dollar-shekel exchange rate fluctuation bands, but he won't get Finance Minister Silvan Shalom to agree to this, even by using threats. During internal discussions at the treasury Shalom said, "Have I gone crazy enough to cancel the fluctuation bands? Klein is quite capable of making the exchange rate go down to NIS 3.80 to the dollar."

So a sharp drop in interest rates is still a long way off.

But the economic truth is that Klein does not have to take part in any discussion, agreement or package deal in order to admit the serious errors the central bank has made so far. After all, it is unreasonable that in a period of such deep recession, with the inflationary expectations at such a low, that he continues to maintain real interest rates at the insane level of 4-5 percent, as if we were in the midst of a celebration of economic growth.

The central bank's storehouse of excuses, however, is inexhaustible. Last December, Klein said that the economy would grow at a rate of 3-4 percent in 2001. A year ago, he often spoke about the dangerous proximity of Israeli interest rates to those in the United States, but this excuse disappeared when U.S. Federal Reserve Chairman Alan Greenspan lowered interest rates sharply over the past year.

When inflationary expectations dropped, the Bank of Israel invented the "forecasters' index," which never had a leg to stand on. When inflationary expectations continued to decline, bank sources said that the money market was not sophisticated enough and presented some ridiculous proposals. And when the forecast for one year was still "too good," they increased the range to three years. When there was a slight depreciation in the value of the shekel in relation to the dollar, they said it would lead to a wave of price increases. I could go on and on.

The very worst was in December 2000, when Klein bowed to the pressure of the criticism and announced that the central bank was "carrying out a thorough investigation" into why he had missed the inflationary target for 2000 by a broad margin (just as he missed the targets for 1999 and for 2001). Back then he said: "This failure obligates us to examine ourselves, and the moment we reach some conclusions, we will inform the public."

He must have almost died laughing when he said that. But nobody saw those conclusions.

All this is nothing compared to the "horror show" the bank put on recently. Journalists were invited to a performance during which the monetary department gave a report on a "model" that showed that inflation was about to rise sharply and that in order to prevent this danger, the bank had to quickly increase (!) interest rates by half a percent. This was just a month-and-a-half ago, during the depth of the harsh recession, the layoff announcements and the factory closures. So what happened to the "model?" Is it already off the mark? Is there a new one on the way?

It's time to put an end to the excuses. We don't need a package deal or a policy change or capital market expansion or a cancellation of the fluctuation band. Klein has to lower interest rates by 1-2 percent now, so as to somewhat rectify the damage he has caused the economy so far, and to prevent it from getting worse.

After he lowers the rates, and not a moment sooner, he can sit down with Shalom and examine and come to an agreement on all the reforms in the money and foreign currency markets. But first of all, he has to lower interest.