Very Low CPI: Who Wins, and Who Loses?

On the 15th of every month, the Central Bureau of Statistics releases the Consumer Price Index for the preceding month. Every year, the CBS processes the monthly figures, and announces the inflation rate for the previous month. So who benefits from a low CPI? Who is hurt? What does low inflation do to inflation, interest rates and the national budget?

At -0.9 percent, last month's CPI represented the sharpest drop since January, 1986. It surprised everyone, and fueled speculation that the Bank of Israel will cut its lending rate, the dollar will bounce back, and the criticism of Bank of Israel Governor Stanley Fischer will move up another notch.

The bank's mandate is to maintain price stability by controlling interest rates, while keeping them as low as possible to avoid strangling the economy. High interest rates hurt people with bank overdrafts, mortgage holders and business owners, and depress employment rates and economic growth.

Low interest rates, however, encourage consumption and investments, which can spur inflation. That signals the Bank of Israel to put on the brakes by raising interest rates in order to prevent the economy from heating up too much.

Conventional wisdom holds that a low CPI is proof of economic stagnation. The public tightens its belt, which encourages retailers to cut prices. When that happens, the central bank can reduce interest rates without fear of stoking inflation in order to increase consumption, investments and economic activity.

That is not the situation today, however. September's low CPI, which is expected to continue in October at -0.5 percent, is the result of the fall in the dollar - or, more accurately, the strengthening of the shekel, as well as the drop in energy prices. When the dollar falters, imported goods purchased in dollars become cheaper.

The government's goal is growth, which increases its tax revenues, reduces unemployment and raises the standard of living. But the government is restricted by the central bank's control of interest rates. The Bank of Israel is independent of the government, a separation that allows it to set interest rates based on optimal national economic health without being affected by the government's interests.