Karnit Flug: Out From Fischer’s Shadow

In an interview with TheMarker, the Bank of Israel governor speaks about the budget, relations with Netanyahu and Lapid, home prices and interest rates.

Eyal Toueg

It’s been 11 months since Karnit Flug was formally given the reins of the Bank of Israel. Coming after Stanley Fischer, a globally recognized policy maker and now No. 2 at the U.S. Federal Reserve, she has a tough act to follow.

But in an interview with TheMarker excerpted here, her first with the printed press since taking office, she expressed no doubts. “I don’t feel like I’m sitting in his shadow,” Flug said. “We meet in professional forums and talk. But if you are not here, you aren’t familiar with the details. We don’t consult on a regular basis.”

Let’s talk about the 2015 budget. You tried with all your might to prevent the deficit from exceeding 3% of gross domestic product, but for now at least it’s been set at 3.4%. Is anybody listening to you?

“It’s important that our professional stance has been heard, including the risks of one policy or another. We are active partners in the deliberations on the state budget for next year. I have no doubt that the position we have articulated will influence the decisions being made. Even if the deficit exceeds 3%, the decision will be influenced by what we said regarding the risks involved.”

There’s a feeling that your voice isn’t being considered in the budget talks.

‘They were listening to me’

“I had the sense that they were certainly listening to me and taking what I said seriously. They were listening to me.”

You know that people say that you are weak?

“The views I express are based on a lot of knowledge, a lot of professionalism. Our strength is our ability to express a professional view without fear.”

How would you describe your professional relations with the prime minster?

“Our relations are good. We meet frequently. The prime minster listens to my professional views that I offer attentively. That’s why we meet.”

‘Disagreements’ with Lapid

And your relations with Finance Minister Yair Lapid?

“Personally, our relations are very good. On the professional side, we have disagreements.”

How can you say that? Did he try to undermine your authority, even calling you a “clerk” and “history?”

“I try to focus on professional deliberations. It’s important to stress that we have regular, ongoing and good relations between officials at the Bank of Israel and the treasury.”

What do you think about a finance minister who says economic policies don’t need to be done through economists?

“It’s important that economic decisions are made on the basis of knowledge and understanding, and we at the Bank of Israel have the knowledge, understanding, experience and empirical data. We contribute to decision making and the public discussion.”

Why were you unable to put a brake on rising home prices?

“Home prices are first and foremost a question of supply. In 2013, there was a big increase in housing starts and completions. There were 43,000 starts. If we had kept up at these levels, we would have seen a decline in prices, except that in 2014, unfortunately, we registered a decline in housing starts and applications for building permits because of the uncertainty in the market.”

You mean the plan to exempt many buyers of new homes from the value-added tax?

“The zero-VAT plan no doubt created uncertainty, among things because the criteria for the homes that will be included in the plan are still not known, so it’s hard for builders to make decisions.”

In other words, we were on our way to lower housing prices when along came zero-VAT?

“The decision put the building industry into a freeze that prevented a turnaround in home prices. I hope that after the uncertainty is lifted, the Israel Lands Authority will market land, and there will be an increase in permits and in building.”

‘Don’t cut civilian spending to pay for defense increase’

Why hasn’t the Bank of Israel taken a stand on the defense budget?

”I don’t know how many Iron Dome batteries we need to deploy, how many Windbreaker [antitank defense for troop carriers] we need to install and how much it will cost to locate tunnels. I do know that big structural changes in the defense establishment can’t happen in one day. If it’s found that we need to increase defense spending, we need to do it within a deficit target of 3%.

“Our stance is that if defense needs demand a bigger budget, then we need to pay for it through taxes, which is best done by rescinding tax breaks and not by reducing civilian spending. The budgets of the civilian ministries are low and any reduction would hurt education, health, welfare and infrastructure and the potential for long-term economic growth …”

‘Standard of living - it’s complicated’

The Bank of Israel recently published a study which showed that Israelis’ standard of living had risen in the last decade. That elicited a lot of angry reactions from people who say their personal experience is exactly the opposite.

“It’s a complicated picture. Research doesn’t always match how people feel and doesn’t express every aspect of one’s standard of living. There are people, the young for example, who want to buy a house but homes are too expensive. On the other hand, rents have not risen over time faster than wages.”

What is the Bank of Israel doing to help contain the rising cost of living?

“Our policy of preserving price stability is the broadest and most correct way to see our contribution to the issue of standard of living.”

And what about bank fees? It doesn’t seem like the central bank is attacking that with much gusto.

“It’s not true that the Bank of Israel has failed to act in that area. The Zaken committee on banking competition … has undertaken clear and important steps. … Its proposals are being implemented – a credit database that will serve as a basis [for exposing] the loan market to competition. We are working quickly to create a bank identify card, which will work the same way as the credit database, even faster. We have acted to reduce barriers to changing banks. Thanks to the banking commission, people can compare the cost of banking services.”

What about the shekel? It seems the Bank of Israel has decided to help exporters at the expense of consumers who benefit from cheaper imports.

“A temporary appreciation of the shekel, which deviates from the exchange rate equilibrium, can cause loss of industries and factories that would normally be able to flourish. We have prevented very serious injury to workers, who are also consumers. The steps we took on interest rates and foreign currency [intervention] have led to a depreciation of the dollar in the past six weeks.”

How long will we have near-zero interest rates?

“The rate will remain low as long as needed. We examine the economic situation month by month and act according to a list of criteria like inflation, the state of the economy and global conditions. The current rate of 0.25% is appropriate for a slowing economy with very low inflation, a shekel that was until recently appreciating and tepid demand. When these conditions change, we will decide whether there is room for changing the rate. But so long as the global environment is poor, we can expect it to remain as it is. When inflation and interest rates globally are zero, Israel’s rate will remain zero.”