Stanley Fischer Tells Haaretz: Israel Had Proper Policy During Financial Crisis

The Bank of Israel governor on helping Israel weather the global financial crisis.

Stanley Fischer has reason to be pleased as he nears the end of his term as governor of the Bank of Israel. Thanks in part to his stewardship, Israel has weathered the global financial crisis far better than many other Western countries. And in between dealing with the crisis, he has also managed to accomplish some of the goals he set himself upon taking office, such as resolving a longstanding labor dispute at the central bank. There is widespread speculation that he will be asked to stay on for another five-year term. But when it comes to his plans for the future, Fischer is keeping strictly mum.

We got through this crisis well. Why?

"There are two reasons. First off, because we started in a much better situation than most other countries. The banking system was good, without problems in the mortgage market. We had a current account surplus in 2007, a balanced government budget, and households didn't have significant debts compared to those in other countries.

"Every Israeli loves saying how big his overdraft is. Israelis are very proud of this. But if you look at the macro, then Israeli households don't have large debts compared to other countries.

"Second, because we started off in a good situation, we needed to do less. In terms of monetary policy, we did more or less what other central banks did, even if not exactly at the same time, aside from one thing - buying foreign currency.

"Intervening in the foreign currency market wasn't easy, because the Bank of Israel hadn't intervened in 10 years and we didn't want to change that situation. But in the end, we changed it. We began intervening, and we managed to return the dollar to a more reasonable exchange rate. This contributed to exports. The exporters continued to export - admittedly, not at the pre-crisis pace, but the decline was more moderate than it was in most countries.

"On the fiscal side, we had a government that couldn't go wild. Until June 2009, the government couldn't increase its expenditures, because it hadn't managed to increase its budget. So it let the tax deficit increase due to the decrease in collection, but it didn't do any more than that. Thus we wound up with a deficit that we expected would be 6%, but in the end was a little more than 5%.

"So we didn't go wild, but we didn't do nothing. I hear sometimes that we proved to the world that it's possible to raise taxes and get out of a recession ... [But] by and large, our taxes dropped significantly and that contributed to our success. I think we adopted the proper policy during the crisis, and the most important thing is that we had a financial system that continued to function. That was what differentiated us from Britain, the United States and Europe."

Let's go back to the time of the crisis, a year ago. Tell us, was there pressure to take more aggressive action?

"There was pressure in a certain sense. Every exporters' organization would come to tell you what its problems were. I think this is legitimate, and I don't consider this exceptional pressure. They frequently came with old solutions that didn't work then and wouldn't work now, but you need to balance this with the fact that frequently, there are things you didn't consider.

"In terms of the political pressure, I was surprised that it wasn't that strong. One of the reasons was the cooperation between the Finance Ministry and the Bank of Israel. We forged a joint stance on every suggestion for help here, a safety net there, and this helped the economy."

Does this cooperation still exist - with Finance Minister Yuval Steinitz, for example?

"There's a lot of cooperation, in many different fields, but there is some friction that is part of the [normal] interaction between the treasury and the central bank. That's part of life. It'll pass and we'll return to the proper equilibrium. You've heard me say that we're two doctors with one patient, and we need to work together to be sure the patient returns to full health."

A year ago, I asked you what your forecast was. You said that everyone is pessimistic, so you're optimistic. You made an impressive prediction. So give us a prediction for 2010.

"When you asked me a year ago, I said that people were too pessimistic, because even then it was clear that the exceptional steps being taken to help the banking system and with regard to monetary and fiscal policy had begun to work, and things were stabilizing - and people weren't taking that into account.

"You need to understand that no one - including weather forecasters - ever gives his exact forecast; rather, he gives the forecast that will have the best implications for himself. If they tell you it won't rain and you leave the house without an umbrella you'll be angry, but if they tell you to expect rain and take an umbrella, it won't do you any harm.

"Even now, I think the pessimism regarding the United States is overblown ... [but] growth in Europe is expected to be slower. I do think it's a serious problem that in most of the countries that faced financial crises, the issues with their banks haven't yet been addressed; that's a weak point. Everyone says there's a bubble in China, but they're still growing at an impressive pace, as is India."

There's no bubble in China?

"The Chinese respond fastest to things they see, and they started to increase interest rates a few days ago. A factor that could be dangerous for the global market is that China doesn't let its exchange rate fluctuate.

"In general, all the international financial institutions have started increasing their forecasts for world growth and they're now talking about 3.5% to 4%. I expect the global economy won't return to the 5.5% to 6% growth of two years ago, but I believe that it will go back to growth of 4%, and that the United States will extract itself from the crisis more quickly than Europe."

You bought tens of billions of dollars, the central bank's foreign currency reserves exceed $60 billion, and the dollar dropped to NIS 3.6. That process has run its course, no?

"The intervention [in the foreign currency market] was a huge success. We began getting involved when the dollar-shekel exchange rate was NIS 3.22. If we had had to address the crisis with this kind of exchange rate, we would have paid a very high price. We gave the exporters and the economy a year and a half of grace, and this was very important.

"Now we need to address the fact that people don't expect interest rates in Europe, the United States or Britain to start increasing over the next few months, while they see recovery in several developing markets, like Asia, Brazil and Israel. Money is leaving developed countries for countries that are recovering from the crisis, as well as developing nations. This trend will continue until people begin believing that interest rates are going to rise in developed countries - and that will happen within the next few months.

"I won't describe our strategy, but I'll say two things: The exchange rate is very important for a small, open economy like Israel's, so the Bank of Israel cannot be indifferent to it. In addition, Israel has a very strong economy, but in a strong economy at a time like this, there are forces that will cause an appreciation [of the shekel]. As I said, in my experience, when everyone is expecting a financial variable to move in only one direction, it's time to start being worried."

During the crisis, while banks around the world were collapsing and central banks were taking unprecedented steps, you were busy with Shari Arison, who refused your demand to oust Bank Hapoalim chairman Danny Dankner, and with Dankner, who refused to go. What was that like?

"Now that it's over, I can say it was no joke. One of the most problematic things was that we were constantly having to worry about the stability of the financial system, that every morning I would wake up and check what was being written and what was happening in terms of faith in the system, whether it still existed.

"We had to conduct that unpleasant process in order to maintain stability in the banking system. So yes, it was unnecessary, it was undesirable, but once it began, we had to manage it."

What did the conflict and the support that Arison and Dankner received teach you about the Israeli economy?

"This is something that wasn't good for the economy. I don't want to go back to it. There's an expression in English, 'let sleeping dogs lie.' This problem isn't intruding at the moment, and we shouldn't let it return. I hope you understand that that's an expression."

"Because Macroeconomics is strongly related to everyday problems - it doesn't provide much pleasure or satisfaction to those who are searching for abstract topics or intellectual entertainment. Macro theory is not very organized; its rims aren't neatly primed. But the worlds' rims aren?t always neatly primed." (From the preface to "Macroeconomics" by Stanley Fischer, Rudiger Dornbusch and Richard Startz).

Anyone who has studied economics in the last 20 years is well acquainted with the book you wrote together with two friends. Even though the book is called Macroeconomics, it is known by many as Fischer-Dornbusch. The question arises whether parts of your book need to be rewritten due to the events that have occurred over the last two years, or are you comfortable with the canonic literature on economics?

"There is a phenomenon known as the liquidity trap (a situation in which the interest rate is low or non-existent, and the demand for money and the economy's activity aren't as encouraging). In the first edition of the book, published in 1979, there was an extended section dedicated to this issue. Over the years this chapter became shorter and shorter, until in the early 1990s, when Japan entered a liquidity trap, the chapter became longer again. Today, this chapter would be longer and more detailed, and we would definitely have more to say about the management of monetary policy. What the Bank of America did in the crisis, which we are now coming out of, was unprecedented, and we would have to write several pages on the way they dealt with this economic collapse.

"Moreover, we would need to write about the importance and the stability of the financial system. We knew all this in the past - but we are only coming to understand it now.

Why did we succeed to revive the economy by lowering the interest rates and the Americans did not?

"Because we had banks that could work with low interest rates, which the Americans didn't have. We've said it in the past, but when you have an example - you have a better understanding.

You began to describe the first steps of liquidity that occurred with the start of the economic crisis, but with your permission, I would like to take you back a year or two. There are many bank governors, plenty of regulations, so many committees discussing Basel I and II, thousands of professors who write about the system's stability, an enormous industry dedicated to researching the financial system and its dependability- and one morning almost everything collapses. Isn't this unbelievable?

"It didn't just happen one morning. Looking back today, we understand that the economic crisis had already begun in February 2007, when HSBC erased the American MBS (mortgage-backed security). That was the start of the crisis. In July-August the extent of the crisis became clear and we called it the Sub Prime crisis. Later it started to infiltrate the entire economy, and in March 2008 Bear Stearns Companies, Inc collapsed. But the crucial turning point was the failure of Lehman Brothers - that was an accident that should not have occurred, and it made things appear to be the worst financial crisis since the 1930s. But in actual fact it was not as bad as we predicted in September 2008. It took time. At one point they made a bad decision which severely worsened the situation, and we are now dealing with its consequences.

Do you mean the decision to let Lehman collapse?

"Yes, I see this as the turning point. You asked how we would change the books. Now we understand that the problem wasn?t that they let Lehman collapse, but that they let it collapse instantly. I don?t know the words in Hebrew for "Resolution Mechanism." It means to let the institution that has gone bankrupt pay out the debt that it is able to pay, and then come to an arrangement. This didn't happen with Lehman. One morning the Federal Reserve said 'that's it, we're done.' This decision had global ramifications. In Israel we have a Resolution Mechanism that works. We saw this in the Industrial Development Bank of Israel Ltd, which took many years to finally shut down, and it didn't shock our economic system in any way. So we can't say that a bank cannot fail - but we need to play out its failure in a more sophisticated way. All options must remain open.

Why is it that many people felt that we were standing at the edge of an abyss and almost fell in, but yet it seems as though nothing too dramatic will actually happen? Could it be that the solutions came quickly, or perhaps it is related to the fact that the people involved weren't severely penalized?

"If you're talking about the United States, then I'm also surprised that they [the changes in regulation] take so much time, and ultimately may not be implemented. The supervising system in the U.S. needs to change. Many institutions were not supervised at all. But it isn?t certain whether the government has the political power needed in order to change the system. One of the things that surprised me the most was the fact that bankers in the U.S. are still very powerful - despite their failures.

They continue to rule the world? Sometimes it takes time to learn from your mistakes, and I hope our situation is not as bad as you describe.

Are you interested in staying on for another term? What would make you agree?

"When I received this appointment, it was a great honor. I wrote down my goals for the first term. I'll tell you about some of them. I wanted to end the years-long labor conflict at the Bank of Israel. It took time and we did it. There's a wage agreement at the bank, and within a few years, all the accusations regarding salaries will cease. We quietly changed the structure of the bank.

"I wanted to increase the transparency of monetary policy, and I think with our more detailed announcements about interest rates and through our protocols, we achieved that.

"There was another goal - to change the Bank of Israel law. The current law is from 1954. I won't fulfill my goals for the first term if this law doesn't pass, and at the moment there are tons of changes in the new draft law."

So you need a second term.

"So we need a law. Everyone says I want to give the bank governor more power, but that's not the case. Under the new law, a committee will make interest rate decisions instead of just me, the governor, as is the case today. The bank will have a board of directors, and I won't be the only one making decisions. I want to bring modern, corporate governance to the Bank of Israel, for the good of the economy and the country, not for the good of the governors. It's hard for me to believe that this law, over which we've come to agreements with the treasury, won't pass - but I want to see it."

Before now, whenever I asked you about a second term, you answered, "Don't respond to offers you haven't received." Now you're not saying that. Did you receive an offer for a second term? Did the prime minister ask you to serve as central bank governor for another five years and you said you'd stay if they gave you the new Bank of Israel law?

"You're an excellent interviewer. You answer your own questions every time."