Taking Stock / Fallacies of Fogel & Friends

It can't be said that Aharon Fogel springs surprises. He is delivering exactly the goods he was expected to deliver.

Leaks from the sessions of the Bank of Israel advisory committee, which Fogel heads, show that he and Victor Medina are dishing up the same advice we've been hearing for years: Interest rates should be cut faster; the exchange rate should be pushed up; and the inflation target should be too.

Criticism of Bank of Israel policy is justifiable. Like his predecessor Jacob Frenkel, governor David Klein has made several grave monetary mistakes that caused the disinflationary process - that's meant to stabilize prices - to drag out too long. In the last couple of years, the economy has paid heavily for Klein's mistake of suddenly slashing interest by 2 percent in December 2001.

Yet Fogel, it transpires, reached no conclusions from that mistake. On the contrary, he keeps chanting mantras that, in part, do not fit Israel's economic reality.

l Raise the inflation target - Here Fogel is revisiting an idea dating from the late 1990s. Proponents claim that if the inflation target were higher, the Bank of Israel would have more room to maneuver. It could lower interest rates more easily, and "pay" with "a little more inflation."

But economic reality is otherwise - maybe even 180 degrees otherwise. The moment the government signals to the public that it wants higher inflation, inflation expectations will surge. And that could force the Bank of Israel to impose a more restrictive monetary policy. In other words, we'd pay a double price: We'd not only have higher inflation, but we'd also pay higher interest rates.

l Reduce short term interest faster - Fogel & Friends advocate cutting interest by more than 0.3 percent a month, and maybe even wielding the ax several times a month.

First of all, let's remember that until recently, the Bank of Israel was cutting interest by 0.5 percent a month, and it did so consistently and fast. It only shifted to a slower 0.3 percent monthly pace after some time, when interest was already low.

But do Fogel & Co. really think that today, with nominal central bank rates at 4.5 percent, the governor should continue hacking away by 0.5 percent a few times a month? This would mean that in a couple of months, we'd be down to 3 percent. But back in reality, interest on the pound sterling in Britain is 4 percent, after two hikes since November 2003. Australia and New Zealand raised lending rates to 5.25 percent and are expected to go further. Interest in the euro bloc sank as low as 2 percent in May 2003, and isn't expected to drop further any time soon.

Say Fogel and his colleagues are convinced that Israel is Europe in a skullcap and we should equalize our interest with that of the euro bloc. But should we really race in giant steps to achieve that within three months?

l Push up the exchange rate through faster interest rate cuts - Fogel and his chums see interest mainly as a tool to control the exchange rate. They think interest should be lowered fast in order to weaken the shekel, thereby ending the recession.

Do they really think the Bank of Israel can control the exchange rate? Haven't they learned - from the vast experience of the international market, or the 10 years in which Israel's currency market has been liberated - that exchange rates are influenced by a long list of factors, that cannot be predicted or guided? Even assuming the central bank could influence the currency market, should it? And even assuming it can control the rate at which the shekel weakens, do Fogel et al know what the "correct" exchange rate should be?

And here's another question: When Fogel and his committee associates say "exchange rate," which exchange rate do they mean? The shekel-dollar? But one of the main reasons for the dollar's weakness against the shekel is its dramatic slide against the euro in the international markets. Much of Israel's foreign trade is denominated in euros, and the EU currency has strengthened by 40 percent against the shekel in the last two years. Does Fogel think that the Bank of Israel should, or can, impose its influence there too?

The answers to the above question are apparently no, for the most part. Experience teaches that if the central bank strives to attain two different goals in parallel, to set interest and exchange rates, it will lose control on both fronts.

Anybody who actually prizes financial stability and reads about the leaks from the advisory committee could be worried. Klein's contract runs out in 10 months and he's likely to be succeeded by Victor Medina, currently CEO of United Mizrahi Bank and a member of the advisory committee, whose opinions are known to be close to Fogel's.

But maybe one shouldn't be losing sleep just yet. The financial markets are stronger than any given central bank governor, minister, or advisory panel member.

Also, anybody taking over the governor's seat and gaining control of the price of money will quickly discover it's easy to advocate fast interest rate cuts from the advisory tribunal; it is easy to recommend pushing up the dollar and generating growth; but when it's your shoulders bearing the responsibility for financial stability, suddenly things look very different indeed.