Sometimes you get lucky: The case of Israel

Lars Christensen has a post in praise of Stanley Fisher´s conduct of monetary policy in Israel:

According to my friend Stan Fischer said two things. First, Fischer had warned that what was underway in the global financial markets and the global economy would become very bad. In that sense Fischer rightly ‘predicted’ the crisis. Second, and more importantly in my view Fischer had demonstrated just how well he understand monetary theory and policy. Hence, my friend had asked how it would be possible to offset an external (demand) shock to the the Israel if interest rates would drop to zero.

Fischer had explained that there would be no problem at the Zero Lower Bound. The BoI would always be able to ease monetary policy – even if interest rates were stuck at zero. And Fischer then went on to explain how you could do quantitative easing and/or intervene in the currency market.

I believe that Fischer’s de facto NGDP targeting rule is exactly what has ensured a very high level of nominal stability in the Israeli economy over the past decade. This is a remarkable result given the very sizeable negative shock in 2008-9 and the ever present political and geopolitical shocks to the Israel economy and markets.

That´s quite true. The charts show both Israel´s and US NGDP and Trend. While in the US NGDP tanked in 2008, in Israel it continued along the original trend level path.

The different reaction of each Central Bank to the oil shock explains the different outcomes. While an oil shock (a negative supply shock) increases inflation and reduces growth, those effects tend to be temporary and the best monetary policy can do is to keep nominal spending close to trend. The charts show that by doing exactly that Israel avoided the real output contraction that befell the US.

Just like during the Greenspan tenure in the US, it appears a de facto NGDP level target rule was being followed. I only wish, now that he has been nominated (pending Congressional approval) for Fed Vice-Chairman, that Fisher had been explicit about the rule. Unfortunately, that´s not so. Just before stepping down from Governor of the Bank of Israel (2005-13), Fisher said in a speech:

In my work as a central banker, I have made much use of my knowledge of central banking history around the world. Many of the events that are taking place today remind me of events from the past, and knowing the lessons from the past helps us develop policy in the present.

A prominent example of this is that of Ben Bernanke, who learned the lessons and the mistakes in handling the Great Depression of the 1930s during his research, and knew how to deal with the most recent financial crisis differently and more efficiently than how they tried to handle the situation in the 1930s.

We, the central bankers, thought at the outset of the crisis that we were about to experience another great depression like in the 1930s, when the unemployment rate in the US reached 25 percent. I am not here to claim that the current situation is good, but during the current crisis, US unemployment rate hit 10 percent and then began to decline, and I am sure that the situation would have been very different had Bernanke not acted according to the knowledge that he acquired in the course of his research.

Apparently, learning was only partial and selective because he also said:

There are those who support setting a nominal GDP target. I think that this is very impractical. The data that we receive on nominal GDP are very unstable.  There are changes of whole percentage points between the various estimates of GDP. For this reason, I think that there is no reason to use nominal GDP as a target.

Maybe he thinks inflation, output gaps and natural rates are precisely defined and known!

To replace Fisher as Governor of the BoI, Prime Minister Benjamin Netanyahu had chosen Jacob Frenkel, who had been BoI Governor from 1991 to 2000. But that didn´t happen because it came out that Frenkel had been involved in a shoplifting incident in 2006:

Prime Minister Benjamin Netanyahu’s choice for the next Bank of Israel governor has withdrawn his candidacy for the post, after an investigation was opened into an alleged 2006 shoplifting affair at the Hong Kong airport.

In an interview with Channel 2 on Monday, Frenkel lamented that despite his willingness to set his own plans aside and “lend a hand” by accepting the post of the central bank’s governor, he has become the subject of slanderous accusations.

I think Israel was lucky because, according to Frenkel´s stated views, his “hand wouldn´t have lent much”. According to this article on his appointment to head the BoI:

At the conference, Frenkel had an enlightening conversation with Axel Weber, today the chairman of the Swiss banking group UBS and formerly the leader of Deutsche Bundesbank, the German central bank.

“We were both formerly central bankers and I personally can say I wouldn’t want to be a central banker today, with interest rates at rock bottom, because there’s almost nothing that can be done,” Frenkel observed. Every central banker knows that keeping interest rates that low isn’t sustainable, he added: “That doesn’t mean it’s a bad policy, but that’s not a place anybody would want to be.” The Bank of Israel lending rate is now at 1.25%, not quite rock bottom but certainly very low.

No one can say luck doesn´t exist!