The low point reached by the shekel-dollar exchange rate has reignited criticism by opponents of the Bank of Israel's intervention in the foreign currency market. It should be stated at the very beginning - these attacks on the Bank of Israel are difficult to explain, because its policy has achieved success.
In order to assess the Bank of Israel's policy, it is necessary to first look at the basic figures for the Israeli economy, which is in a very strong position. Israel has a balance of payments surplus, and having a foreign currency surplus has been Israel's dream for generations. Israel's natural gas is also helpful, because it reduces the need for foreign currency. We are in a state of full employment, and the economy is growing without any inflation. We are still below the inflation target, but this is a worldwide phenomenon that is still hard to understand, and even US Federal Reserve chairperson Janet Yellen regards it as a mystery.
The bottom line is that the macroeconomic figures that the Bank of Israel is striving to achieve are good, so what are they complaining about?
Keep in mind that the world has been in an anomalous state of low interest rates for a decade. Most of the countries relevant to us are implementing an expansionary monetary policy, and the situation in those countries is poorer than in Israel. The Israeli economy is regarded as attractive, and this is putting money into the economy. The Bank of Israel cannot oppose this trend, and is also not trying to change the direction of the exchange rate, which is determined by fundamental economic laws. It is acting, however, to regulate movement, so that the appreciation of the shekel does not exceed the basic principles of the economy. The Bank of Israel is therefore intervening a great deal, and with good reason, in order to combat irregular volatility. The dollar weakened against the euro over the past year, which also reduces its value here. The Bank of Israel cannot prevent this.
There is no need to respond to the argument that the Bank of Israel is "protecting" exports, because we can ask the exporters whether this is what the Bank of Israel is doing. The Bank of Israel is not attempting to change the equilibrium of the real exchange rate, as dictated by basic economic forces.
Last month, an international conference took place in Jerusalem on the subject of intervention by central banks in the foreign currency market. Participants included representatives of the Swiss central bank, which itself is adopting a policy of intervention in the foreign currency market to the same extent as we are, or even more. Interesting conclusions were presented at the conference indicating that this intervention is effective in the short term. It does not alter the basic data of the economy, but it is effective in achieving the the short-term objective of preventing exceptional events in the foreign currency market. Articles were also presented at the conference that used an elegant structural model to prove that intervention in the foreign currency market is a legitimate tool for bolstering economic well-being.
The Bank of Israel is not operating as a speculator, and is not seeking to maximize its return. There is a certain degree of risk that the Bank of Israel is willing to assume for the money it uses to manage its monetary policy. The investment portfolio that it manages is very conservative and sound. At the same time, as this portfolio has grown, a larger proportion has gone into risk assets. 20% of the portfolio is invested in risk assets - overseas shares and corporate bonds. Some of these investments are managed by external specialists, and some by the Bank of Israel's experts. The return that the Bank of Israel is obtaining corresponds to the risk that it takes, which is low.
For the past decade, the Bank of Israel has been operating in an unusual world of negative or negligible interest rates. Under such conditions, irresponsible experiments or games are not taking place. Where its investments are concerned, retrospective wisdom is no wisdom. An optimal investment portfolio can always be assembled in retrospect.
The Bank of Israel is not attempting to change the exchange rate's direction; it is only trying to prevent it from deviating in relation to models that are not an exact science. The test of success for the Bank of Israel's policy is the superb stability and macroeconomic state of the Israeli economy.
The author is a professor at the Tiomkin School of Economics in the Herzliya Interdisciplinary Center.
Published by Globes [online], Israel Business News - www.globes-online.com - on January 17, 2018
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