Interview with Dr. Karnit Flug at the 2013 Eli Hurvitz Conference on Economy and Society
On November 6, 2013, a video interview with Bank of Israel Governor Designate Dr. Karnit Flug was broadcast at the 2013 Eli Hurvitz Conference on Economy and Society. This was Dr. Flug's first public interview since being named Governor of the Bank of Israel. Dr. Flug was interviewed by Mr. Yarom Ariav, the director of the Eli Hurvitz Conference, two days before the conference itself. Dr. Flug, who has attended the conference for many years, was not able to attend the conference due to overseas commitments.
The interview begins with Yarom Ariav congratulating the Governor-Designate on her appointment and welcoming her to the conference. Find out what she said by reading the English translation below or watching the video below, which has English audio translations.
Q: You also serve as the financial adviser to the government. What are the three main challenges that the Israeli economy faces?
A: In the tradition of economists, I would like to divide the challenges into long-term challenges and short-term challenges. Let's start with the long-term challenges. I think that the main challenges to the Israeli economy in the next years is to continue growth at a satisfactory rate, while creating a situation in which the fruit of that growth will be divided equally in a broader manner to all the segments of the population and will contribute to a reduction of poverty and inequality. I think it is important to say that this challenge is a great challenge, since in retrospect, we see that economic productivity grew very slowly in recent years, in a rate that is actually slower than the rate in developed countries, and that means that a gap has developed.
Beyond this, if we look toward the future, the demographic trends are such that if we look at the segments of the population that participate less in the economy—Israel's Arab citizens and ultra-Orthodox Jews, who participate less in the workforce and who have lower rates of productivity—their weight in the population is growing; therefore, this is an especially great challenge. This means that we will have to work hard to integrate these populations in the labor market, to increase their human capital, and to improve the business sector in a way that will really contribute to increasing productivity.
With regard to short-term challenges, in the short-term, I think we are working in a global environment that is very challenging, first of all because the level of global activity is diminished, and that means that there is less demand for our exports, and because the policy environment is one that poses challenges to Israel's policy: the low interest rates in the world—their meaning is that our monetary policy environment must adapt itself, both because inflation is low, because growth is relatively low, because Israel's interest rates are very low, and this of course creates challenges such as increased housing costs and appreciation. These are the types of challenges that we are facing. It must be noted that part of the coping with these challenges stems from the fact that the Israeli economy continued to grow during this entire period, and this too contributed to appreciation and to an increase in the price of housing. This is, of course, a challenge that our policy must address and when we begin to see that this period of recession is ending in the rest of the world, this will, of course, also ease the situation for us.
Q: Part of your answer is perhaps related to a question that I wanted to ask you. To what extent is the size of the government the desirable size of the government? This question, to a certain extent, depends on political perceptions (this came into sharper focus during the social protest of 2011). What do you think of this matter?
A: As you already mentioned, I think the size of the government is essentially a reflection of a social preference. On the one hand, there is the extent of the services that are given to the public, and on the other hand, there is the rate of taxation.
Q: Just to clarify: We are not talking about the number of Ministers in the government; we are talking about the overall expenditures of the government.
A: Indeed. We are talking about overall expenditure of public service, as a percentage of our GDP. I think there could be a relatively small government, with lower rates of taxation, or a larger government, which demands a higher rate of taxation. Essentially, both of these two situations, with appropriate guidelines, could be economically successful. Consequently, I think that the choice between them is a social choice. What is important to emphasize, from a macro-economic perspective, or from the point of view of an economist per se, is that it is important to remember that these two things are intertwined. If you want a government that is going to provide greater services, and a higher level of services—a government that will invest in and perhaps actively support growth engines, the implications of this is that there will be greater expenditures and also higher taxes. Therefore, from a macro-economic perspective, we cannot allow ourselves to have a deficit that is growing; we must reduce the weight of the national debt in the overall GDP. This is when you look at it from a global perspective.
In terms of our priorities, I think that as long as Israel's defense expenditures are high, the implications are that if we also want a high level of public services, in a rate that is similar to that of developed countries and of similar quality, the government will have to be larger than in other developed countries, and that means that taxation will also be higher. On the other hand, if we want our public expenditures and tax rate to be similar to those found in other developed countries, given our high defense expenditures, we will have to offer more modest public services.
Q: You elegantly avoided my question, but that is okay, since we got something interesting instead. What about the global issue? The world is flat, as Tom Friedman has said. Bank Governors all over the world have been working in recent years on very broad monetary policy. We can see what has been happening in the United States with its low interest rates. How long do you think this can continue before we start to see a change in the trends? And what will happen to the policy of the Bank of Israel when we indeed see a change in the trend?
A: First of all, as long as the global policy is very broad, and that finds expression both in very low interest rates and measures of quantitative expansion in developed economies, especially the United States, the implications are that the interest rates in Israel will also be very low. This environment is both made possible by the low inflation and is also necessary given the relatively low level of activity that we have and the need to support it. As we know, the low monetary interest environment in the world, as well as the long term interest rates, which are also relatively low, results in the fact that—as I said earlier—one of the challenges is that this encourages people to take out mortgages, we even see investors who don't have other good alternatives that are better for their investments, investing in the housing market. In addition—and this is related to our good performance—there is also appreciation pressure. I think that when the signs of recovery in the American economy get stronger (and regarding this matter, the Fed is fairly clear that it wants to see greater recovery before they begin a process of "tapering"—that is, a gradual decrease in acquisitions by the Fed), that is when some kind of change will begin to happen. And in truth, I think that in terms of our monetary policy, it will make it easier for us in some way, because it will reduce the pressure that we see now stems from the very low interest rates at the moment. Thus, from our standpoint, I think the change in monetary policy in the United States will firstly indicate that growth in the U.S. is stronger. That will be good news for us in terms of demand for our exports, but beyond that, I think it will also reduce the burden on our monetary policy. As for when, in the meantime, we have seen a delay, and I will not attempt to prophesize.
Q. If we are talking about revaluation, the question that concerns every exporter, or every manufacturer, as well as citizens, is: What will happen to the dollar? After all, the tools that the Bank of Israel has in its toolbox have pretty much been utilized to the maximum with the reserves of foreign currency that the bank has at its disposal. What else can be done?
A: Firstly, I would back up a bit and say that our historical experience has been that the growth of the economy always rests on export, and export...has been, and I believe will continue to be, the engine of growth. I think that the recent period has created a particular challenge to export. Because of the relatively good performance of the Israeli economy, we saw a period of appreciation. The Bank of Israel attempted, by means of the policy of intervention that we actually started in 2008, to help the employed sector deal with this phenomenon, which is connected to the global circumstances, as I mentioned earlier. I think that as we look towards the future, in the end, the ability of export to cope with the situation is connected to an increase of productivity and increased efficiency, and what our policy can do is to allow a period of time for adaptation; that is, when there is a temporary period in which the pressure to appreciate is particularly high, if we can ease those pressures, by means of our policy, and in so doing to allow time for adaptation, I think that will allow exporters to overcome the pressure. In the end, I think that when the global economic circumstances normalize, there will be less need for this kind of intervention.
I would like to add one more point, which is related to our intervention in the production and utilization of natural gas. As is known, the fact is that that we know at this time that in the future we will have natural gas that we will produce ourselves and that this will reduce our need to import fuel. I think the response of the foreign currency market was an over-reaction and was in essence an example of "overshooting"—it was a reaction in the present that was based on improvement in the future. Again, in order to deal with the phenomenon of overshooting, we added the purchasing of currency to our intervention policy in order to offset the influence of the gas on the balance of payments, and in this way to reduce the impact of the gas on the exchange rate.
Q: As Governor of the Bank of Israel, do you have a dollar to shekel rate in your mind that you won't allow us to go under because it will be very harmful to the economy?
A: Of course I will not talk about a specific number. I think what we want is to allow for a period of adaptation. I think that we all have desire a strong market with a very low rate.
Q: I would like to talk about the banking system. As you know, the control of the banks is now under your purview. Some people say there is some kind of tradeoff between the stability of the banking system, on the one hand, and competitiveness, on the other. The Bank of Israel, as the organization that is responsible for stability, tends toward stability, and does not allow free competition of the banking system. What would your policy be on this issue?
A: I think there is a place to increase competitiveness in the banking system, especially for homeowners and small businesses. I think that increasing competitiveness will not bother competitiveness; it will help streamline the banking system. I think this is the need of the times. I think maintaining the stability of the banks is intended first and foremost to protect the money of the customers of the bank, and is a basic requirement for stability and for the high standard of living that we have here. Our experience shows that the price that a civilian has to pay during financial crises that have some kind of connection with the banking system is several times greater than the amount that he has to pay when there is a crisis that does not involve the banking system.... And by the way, when we look at the recent times, the performance of the banking system in Israel during the financial crises of 2008 shows how stable we are. It shows a very important factor in the stamina and resilience of our market. It is also very important to continue to promote the steps that we are taking to continue competitiveness. The bank controller is very attuned to this, and he has a very good ideas. There is a process of adopting and implementing these recommendations now, and we will continue that process.
Q: Is that not eating your cake and having it too?
A: No, I don't think so. I think we can move forward. We are also taking action in this direction. I would not give up on stability, because I think as far as the strength of our economy, it is very important for our stability.
Q: I would like to end with something that is close to my heart, and that is regulation. Don't you think that in the Israeli system, in which we have three different regulators... and none of them are synchronized, and each is working with his own set of rules... don't you think it would be appropriate to make a significant change in this area, either by combining all the regulation or by passing a regulation law? And what have we learned from the great financial crisis? For today we know that some of the problems of the crisis of 2008 were actually regulation problems. So why is there not an initiative to make a substantial change in the regulatory system?
A: I think it is definitely appropriate to reevaluate the structure of regulation. I think there are many lessons to be learned from the experience of the rest of the world. It is very important that the future structure of regulation provide a solution for overseeing financial bodies that are not overseen today, and close the gaps in regulation that are currently in existence in the various parts of the system. It should provide a solution for "shadow banking," prevent regulatory arbitrage, etc. I think that the issue of the structure of regulation should be observed and reevaluated, but as a minimum, I think we should promote the establishment of a committee for financial stability that will institutionalize and organize the relationships between all of the different regulators. I think the main components of those relationships should include the transfer of information between all the bodies, assessment and identification of problems of potential instability that may develop in various places in the system and may fall between the cracks. I think that this issue is very important and I very much hope that in the next few months, we will be able to promote legislation for establishing this kind of committee in order to deal with this issue. This is critical for evaluating the stability of the Israeli economy.