Israel’s economy: moving forward with caution

Spring 2011 in Israel and it’s exit time. Everybody’s doing it.

  • Conduit may be sold for a billion bucks – not bad for 6 years work.
  • Align Technologies bought out Cadent’s dental imaging capability for US$190 million
  • Merck is investing heavily in establishing a Biomed incubator in Israel.

And so the list goes on. The happy days theme can also be found in the stock exchange, almost back to its peak by the end of March. As for unemployment, it’s at a near 3 year low.

So where’s the “but”?

Any first year student of economics learns that you can only use the rate of interest to tackle one problem at a time. However, Israel’s financial policy makers are facing two issues, each tugging in a different direction.

In the left corner, inflation is raising its head, being dragged along by a housing market that won’t stop bubbling. Prices have risen 4.2% in the past year and look like moving on up even more in the near future. April is usually a bad month. So, the Bank of Israel has moved to raise interest rates sharply, and quicker than expected.

On the other side of the ring are Israel’s exporters, crying out that a strong shekel is ruining profitability. The currency has already appreciated 2% in the past quarter and worse is expected. However, higher interest rates push up the price of the shekel against other currencies, leading to even lower profits. Ouch!

So what’s the way out? Stanley Fischer, governor of the Bank of Israel, has long since stopped relying on politicians to do the right thing. So, he has taken a step forward. As Avi Temkin observed:

The practical significance of the decision (to increase interest rates sharply) is that more interest rate hikes will come until the rate is higher than inflation expectations. Export profit margins and mortgage payers’ peace of mind are all subordinate objectives, if that, compared with what the central bank perceives as its primary mission.

A simple bit of responsible home economics. Shame that the finance minister has not found the courage to match this move for now.

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