Dei'ah veDibur - Information & Insight

A Window into the Chareidi World

5 Av 5761 - July 25, 2001 | Mordecai Plaut, director Published Weekly








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Israel Interest Rates Cut Again by 2 Percent
by M. Plaut and Yated Ne'eman Staff

The Bank of Israel's key lending rate will go down to 6.3 percent, the lowest nominal rate since the Bank of Israel was set up in the early 1950s, announced the Governor of the Bank of Israel David Klein, in reducing the August interest rate by 0.2 percent.

This is the fourth interest rate cut in two months, following a 0.4 percent cut in June, and a 0.3 percent cut in July. Israel's interest rate has been falling for 18 months, in line with trends around the world.

For several years, beginning in the tenure of previous Governor of the Bank of Israel Jacob Frenkel (now a member of the senior management of Merrill Lynch, the worldwide financial services conglomerate), Israel has maintained a higher interest rate than the rest of the developed world. This has made its shekel currency strong, raising confidence in the currency and promoting price stability.

Frenkel and Klein have pointed to the fact that Israel weathered several international crises without any severe internal shocks as proof that their policy is effective and is meeting its goals. Business and political leaders have complained that the high rates of interest discourage investment and restrain economic growth.

After the latest move, the gap in nominal interest rates between Israel and the U.S. now stands at 2.55 percent which is very high in view of the fact that inflation in Israel is comparable to that in the U.S. This means that the real rate of interest, meaning the amount that the interest rate exceeds the expected inflation, is close to 4 percent in Israel, a rate that is very high by historical standards.

Klein sees his primary responsibility as fighting inflation, and his decision is based on assessments that the government's inflation targets for the next two years may be met even with lower nominal and real interest rates. The interest rate decision was apparently also affected by the worrisome data published yesterday which indicated that the recession is deepening.

At a meeting with Labor Party Knesset members about two hours before the publication of the interest rate decision, Klein said that if inflation goes up, he would halt the interest rate cuts, and he would not hesitate to raise the interest rate if inflation expectations begin to exceed the targets. Current inflation expectations are slightly below the targets set by the government, according to Klein.

The government's target for inflation stands at 2.5-3.5 percent for the year 2001, 2.0-3.0 for 2002, and "price stability" thereafter of 1.0-3.0 percent. The bank said its monetary policy "strives to achieve the inflation targets, the infrastructure essential for sustainable growth and continued bolstering of the financial stability that the economy has demonstrated in the money, capital and foreign currency markets."

The bank said that this stability had been achieved "as a result of monetary policy, among other things." It went on to claim, however, that its policy "cannot provide the means for offsetting the dampening effect on Israel's economy of factors such as the security situation in Israel and the slowdown in the U.S. economy."

Klein called on the government to issue clearly defined fiscal policies, and called for "greater transparency . . . including a report to the government and the public on the estimated budget deficit for 2001, using internationally accepted definitions."

The bank stressed the need for the government to keep within its expenditure limits, and maintain the downward path of the budget deficit as set out in August 2000. "Any increase in the budget deficit or the public debt are likely to halt and even reverse the downward trend of the real rate of interest in the bond market and the rate of interest on mortgages," the bank explained. "Such fiscal expansion may also undermine the prevailing stability in Israel's markets," the statement continued.

The business community welcomed the cuts and asked for more of the same. The Manufacturers Association welcomed the cut in interest rates. The association's economists called for the governor to continue lowering the cost of borrowing, and pointed out that even after the latest cut.

Business leaders and politicians have called for lower interest rates to stimulate the economy. However it is not clear if this would be as effective as they say. In the US, the central bank has cut interest rates very sharply but has not yet seen a significant response to this stimulus. Other factors such as high energy prices, low stock prices and a bust in technology investment following several years of exuberant boom, are keeping the economy sluggish. Israel is also affected by these factors, in addition to the violence that has plagued it for ten months. Thus it is not clear that even a drastic interest cut would do much.


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