The Bottom Line / It's All Personal, Even the Band

The crawling exchange rate band has been irrelevant for four years. Prof. Jacob Frenkel introduced it 15 years ago to serve as an interim solution between having a government-fixed currency exchange rate policy and a completely fluent foreign exchange rate set by market forces.

Canceling the band last week broadcasts to the world a message of self-confidence, economic resilence and faith that the current government and all successive governments will pursue a responsible budgetary policy with a low deficit, for our politicians know that any financial crisis is liable to lead to a sharp devaluation and to a financial crisis that would threaten their seats in government. In other words, a free and unrestricted exchange rate at the global level derives its importance as a kind of obligation hanging over the heads of the politicians.

A free and unrestricted exchange rate averts financial crises like the ones we have witnessed in Russia and Argentina. Their leaders thought they could maintain an artificially low exchange rate for an extended period. Thus, it is precisely canceling the band of mobility that will increase confidence in the currency and its stability. It will be precisely like what happened when the gates of the country were opened to free movement of foreign currency, which expanded the flow of capital into the country and not out of it, as many had feared.

Thus, Ptachia Bar-Shavit, former senior economist at Bank Hapoalim, is wrong when he calls cancellation of the band a wrong decision. Bar-Shavit was the first to raise the idea of having a policy of crawling exchange rate bands in 1991. However, this does not mean that what was good in the Nineties is also good in this decade, given a completely different state of the economy.

Throughout the past four years, when David Klein asked Silvan Shalom or Benjamin Netanyahu to cancel the crawling exchange rate band, the door was slammed in his face. Each finance minister sought to get something in exchange for the prize, mainly lowering interest rates, as if they were talking negotiations proceeding between two companies and not about one economy and one responsibility. Thus, the two finance ministers deserve condemnation for keeping petty accounts that seriously harmed the economy, employment and growth.

Netanyahu has long understood that the crawling band is superfluous. However, he didn't want to give the achievement away to Klein, whom he wanted to replace in any event. He didn't dare seek a price from Stanly Fischer because he is full of admiration for Fischer, a world-renowned economist, who knows English like the back of his hand. So how could Netanyahu abuse him as he did Klein? Even in economics, it's all personal.

The dollar has started heading north, to many a surprise, the moment the band was canceled. Commentators who do not understand much about economics, rushed to comment that it was a sign of the problem caused by the cancellation. This, of course, is utterly ridiculous because the primary reason for the shekel's devaluation against the dollar has to do with the greenback-euro relationship. Positive macroeconomic data published by the U.S. ganged up with uncertainty regarding the future of the European Union aroused by the two failed EU constitution referenda in France and the Netherlands to boost the dollar against the European currency.

There were others who expressed fear that continued devaluation of the dollar would cause inflation because prices in Israel are linked to the dollar. This also doesn't have much of a basis for justification. Prices disengaged from the dollar long ago, unemployment is still high, and wages in the private sector are still being pushed downward. Therefore, the retailers can keep up their threats. They can even worry about frightening news items in the papers. However, there's not much else to this. They can't raise prices. The market and competition won't allow them to do so.