Download The Governor of the Bank of Israel, Prof

BANK OF ISRAEL
Office of the Spokesman and Economic Information
PRESS RELEASE
June 6, 2011
Abstract of Speech by the Governor of the Bank of Israel at the Israel Economic
Association Conference
The Governor of the Bank of Israel, Prof. Stanley Fischer, spoke today (June 6) at 27th
annual conference of the Israel Economic Association in Ma'ale Hachamisha. The
following is an abstract of his speech.
Four years have passed since the sub-prime crisis began, and two and half years have
passed since Lehman Brothers declared bankruptcy. In this lecture I will attempt to
focus on developments in the global economy since the crisis, and also to touch on
questions and lessons that the crisis presented to the economics profession.
In their 2009 article "The Aftermath of Financial Crises", Reinhart and Rogoff
describe the damage which financial crises have brought with them over the course of
history, which is always expressed in a sharp drop in employment and economic
output, and in a sharp rise in deficits and government debt. In their book, "This Time
is Different", they describe how the dynamic in which crises occur once in several
decades results in policy makers making the mistake of thinking that each time the
crisis is different than its predecessor.
I'll begin with a reference to the global economy. The International Monetary Fund
estimated about two months ago that the global recovery is stabilizing and that the
pace of growth is expected to increase. With that, the recovery is not uniform: Japan,
England, and the euro bloc have not returned, as of the end of 2010, to the level of
GDP which their economies had reached on the eve of the crisis; as of the end of
2010, US GDP surpassed by only 2 percent its record level from before the crisis. In
emerging markets, growth is relatively high, and unemployment levels are low. All in
all, the global economy is expected to grow around 4-5 percent, which is the average
growth rate of the economy since World War II. World trade is also expected to grow
at its long term average of 7-8 percent. The large economies in Asia are expected to
reach within several decades the income levels of Middle Income Countries, even as
inequality in those countries is growing. In South America as well there are extremely
high growth rates.
The global imbalances, which are expressed primarily in China's surplus with the US,
continue, and it is expected that in the long term there will be a continued process of
weakening of the currencies of developed markets vis-à-vis the currencies of
emerging markets. At the same time, it is important to emphasize that one cannot
draw conclusions from this about the short term, since it is very difficult to forecast
trends in the exchange rates.
Financial crises occur, and apparently will continue to occur. However, different
countries dealt with, for example, the last crisis in different ways. It can be seen that
countries such as Sweden, Germany, and Switzerland succeeded in getting out of the
crisis in much better form than other countries. It is up to us, the economists, to
understand what the factors are that lead to certain countries suffering the crisis
differently, and what the policy tools are that allowed certain countries to deal in a
better way.
The first lesson that came out of the current crisis is the issue of macro-prudential
supervision. It means that we must oversee the stability of the financial system as a
whole, and not to settle for supervising each institution separately. In various
countries they are now dealing with the proper approach to supervising financial
institutions and with the structure of regulatory authorities. Another question deals
with the role of the central bank. In the past, it was customary to think that since the
central bank only has one instrument–the interest rate–it can only have one target,
which is to manage inflation. Today we understand that a central bank has additional
tools, and even if using them involves a cost, that cost must be weighed against the
benefit that they can bring in reducing the impact on the economy during a crisis.
A strong fiscal situation is a prime characteristic of the countries which made it
through the crisis in a good position. During a crisis, governments need to choose
between increasing government expenditure in order to motivate the economy during
the crisis, and the need to watch the deficit and debt. In Israel, as is known, there was
an inability to change the government's budget at the onset of the crisis because of the
political situation at that time. Thus, from a fiscal perspective only the automatic
stabilizers operated, and these alone brought the deficit to a level of over 5 percent of
GDP. We should give thanks that the fiscal policy in Israel is stable and responsible,
and aims to achieve long term goals for the deficit and the debt. If in the future we
again find ourselves in a crisis, it is certainly quite likely that we will need to utilize
fiscal policy as well in order to accelerate the exit from the crisis. In Australia, for
example, the fiscal situation before the crisis was such that the debt to GDP ratio was
very low, a situation which allowed Australia's government to adopt an aggressive
fiscal policy which allowed it to exit the crisis relatively quickly.
A current account surplus is a great advantage for a country during a crisis. Countries
which are in a deficit must go through a painful process of adapting trade trends and
their consumption to the new reality, in which they will find it difficult to provide
their foreign currency requirements. Limitations such as these are nearly nonexistent
for countries in surplus. This was the basis of Keynes's thinking at the time when the
IMF was established. As proof, we are witness today to the strength of China in the
international economy, a strength which relies in large part on the huge foreign
currency reserves it has accumulated.
So how, then, are we to relate to the short term capital flows which are entering the
economy now, which stem mainly from interest rate gaps between the Israeli
economy and the large economies abroad? Do these flows represent an optimal
situation for the economy? In my opinion, the existing models today, which support
those who claim we should allow these capital movements to flow freely, do not
represent well enough the fact that financial intermediaries today have a significant
role in the economy.
It is customary to think that the Israeli economy endured the crisis "easily". That is no
small matter – the economy was managed in the years before the crisis precisely in
the way the international institutions such as the IMF and OECD preach – a current
account surplus, responsible and balanced fiscal policy, a stable banking system, and
also monetary policy and a banking supervision system that responded quickly to
developments at the onset of the crisis. We must continue to adopt the correct policy
in the future as well, so that we will be able to continue to grow at an annual rate of 5
percent and more. When will we need to begin to worry? We'll need to worry when
we begin to hear people say the sentence which was the title of Reinhart and Rogoff's
book – "This Time is Different". But primarily we will need to worry when people
say, "It's different for us" – because for us it is not different.