Bank Hapoalim (TASE: POLI) chief economist Prof. Leo Leiderman called on the Bank of Israel to follow the example of the US Federal Reserve System and start raising the interest rate. Speaking at a TV News Company conference, Leiderman said that the Bank of Israel's current policy of keeping the interest rate near zero had lost its luster after three and a half years of a 0.1% interest rate. Leiderman warned that continuing the current policy would expose the economy to many risks.
The Bank of Israel's announcement of its recent decision to leave the interest rate at 0.1% hinted that the central bank was considering changing its policy by starting to raise the interest rate. In his speech today, Leiderman supported such a change, but called on the Bank of Israel to go further by adopting the US Federal Reserve's policy of gradually raising the interest rate.
"The process of gradually and judiciously raising the interest rate, even if inflation is still fairly low, can generate better balances in savings, leverage, and financial stability in the economy," Leiderman said, emphasizing that fluctuations in the shekel exchange rate should not have a decisive effect on interest rate policy. He added, "It is important for interest rate policy to emphasize these factors just as much as the current emphasis on the exchange rate. In general, it is recommended to lessen the current link between the interest rate decision and the shekel exchange rate. I am not talking about a sudden and draconic increase in the interest rate that will create a sharp appreciation in the shekel and harm exports; I am talking about a gradual and measured increase. Past experience and empirical research indicate that a large proportion of the changes in the exchange rate reflect the effect of fluctuations in the global currency markets. The performance of the export sectors depends on an entire array of factors beyond the short-term exchange rate."
Referring to the risks to which the current interest rate exposed the economy, Leiderman said, "According to the forecast by Bank Hapoalim's economic division, the GDP growth rate is likely to reach 3.5% this year and 3.2% next year. The state of our economy is very different than most of the overseas economies. While low demand is the main constraint on increasing output and growth in most overseas economies, the main constraint in our economy is on the supply side, since the economy is in a state of full employment. A central bank exchange rate of 0.1%, which in effect is a negative real interest rate, is no longer suitable for an economy with these characteristics.
"Furthermore, in itself, an interest rate that is too low encourages private consumption at the expense of savings and is liable to increase the risks in the portfolio of investment institutions (such as pension funds) in their search for a return in less conservative instruments than in a normal situation. An interest rate that is too low encourages credit taking and is liable to aggravate pension problems, because the combination of low returns on savings in conservative instruments and the increase in life expectancy are generating a shortage of resources for maintaining the previous standard of living after retirement."
Leiderman, who managed the Bank of Israel Research Department in 1996-2000, added, "I was part of the team at the Bank of Israel that introduced the inflation target regime in the mid-1990s, and I remained a great advocate of this method, which is the most accepted method in the world. At the same time, the current trend in the world is to introduce more and more considerations of financial stability from a more general or holistic perspective of the economy and the financial markets. This approach is currently led by the Bank for International Settlements (BIS) in Basel, Switzerland, which functions as a central bank for central banks, and especially by its chief economist, Dr. Claudio Borio."
Published by Globes [online], Israel business news - www.globes-online.com - on September 3, 2018
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