The Bank of Israel is responsible for an important area, and those chosen to lead it are skilled people. But this does not make either them or the job important. The Bank of Israel's main objectives are fixed in law: to keep inflation within bounds. The tools available to it are limited, and its ability to affect the real economy over time is doubtful.
The job of supervisor of banks is now mostly handled by the international community through the Basel Rules, and all that is left to the supervisor to do is perhaps to tighten them a bit to cover himself, and mainly to fill monitoring reports. Prof. Jacob Frenkel, who is returning for a second round as governor of the Bank of Israel, is a brilliant and multitalented economist. But this does not make the job of governor important. Frenkel will discover that, over the years, the importance of the job, which has become more automatic and simpler, has declined; while, on the other hand, public criticism has become more aggressive and populist.
Since the 1990s, the capital market has become much more sophisticated, and now does most of the work for the Bank of Israel when it presents the future interest rate trend needed to keep inflation within bounds. The market's inflation and interest rate expectations are better over time (crowdsourcing) than the expectations of a single economist or entity, include those of the Bank of Israel. Policy is also derived from the policies of the big central banks. In other words, the market and the big central banks, not the governor of the Bank of Israel, explain at least 90% of the actual interest rate. Attempts to deviate from this structure are immaterial in the long run, or at worst do harm in the form of the interest risk premium and inflation.
The small maneuvering room that is left to the Bank of Israel belongs not just to the governor but to the Monetary Committee where the governor is almost an equal among equals (except in the case of a tied vote). Soon, when the interest rate falls to negligible levels, the governor will not even have this little bit left to do. Frenkel, who is aware of this, said at the Herzliya Conference in March that he "is not prepared to serve as the governor of a central bank in a negligible interest rate environment."
In addition to the interest rate, which is now on autopilot, Frenkel will discover that the issue which took up most of his time in the 1990s, management of the currency, is now left to market forces and economic nature. Frenkel apparently has no intention of continuing Stanley Fischer's interventions in the foreign current market by changing the reserves, and he has criticized these actions because of the high cost of holding the reserves compared with their effectiveness.
The job of economic advisor to the government was taken from the Bank of Israel when the National Economic Council was established in 2006. Fischer also took care to remove from the next governor's agenda the Bank of Israel's operational problems when he passed the Bank of Israel Law and solved the budget problems. In other words, Frenkel has almost no work left.
Although Frenkel was appointed to manage an important area on which he has little influence (like managing the sun), he will still absorb during his term criticism on everything related to it. Initially, he will inherit the public criticism over high housing prices, and later, he will be blamed for low growth, even though this will be due to the slowdown in international trade and cuts in the state budget.
In the second stage, when the interest rate cuts run out, Frenkel will have to manage with his bare hands. In contrast to Fischer, Frenkel will be forced to think about how to get rid of some of the foreign currency reserves because of the high cost of keeping them. This policy will not make him any friends. To sum up, Frenkel has been appointed to manage the sun, and the hot season is coming.
The writer is a macroeconomist.
Published by Globes [online], Israel business news - www.globes-online.com - on June 24, 2013
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