Stanley Fischer: The Economic Stabilisation Program and its effect on the
Israeli economy today
Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Democracy
Institute Conference on Economic Policy ("Caesarea 2005"), Jerusalem, 30 June 2005.
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The Minister of Finance, the President of the Israel Democracy Institute, the Academic Director of the
Caesarea Conference, honored guests, ladies and gentlemen:
I am happy to be here today, at the Caesarea conference, surrounded by so many friends and
colleagues. It gives me special pleasure to have been given the opportunity, for the first time, of
participating in this celebratory "barmitzvah" conference as Governor of the Bank of Israel. As you
know, the conference organizers thought it appropriate to hold a special event two days ago to mark
twenty years since the Economic Stabilization Program of 1985 (the ESP).
The older ones among us surely remember that twenty years ago, in the mid-1980s, Israel was
wallowing in the throes of a deep economic crisis. Annual inflation had soared to three-digit figures,
and everyone in the country-householders, businesses, factory owners-was engaged principally in the
day-to-day search for ways to avoid the damages caused by hyper-inflation. Economic and financial
instability did not simply occur by chance. It occurred against the background of an oversized
government with a large, nay huge, deficit. Alongside the government acted a central bank which was
far from being independent, as it was obliged to print money to finance the government's large deficits.
The stabilization program introduced in 1985 was a turning point for the economy. Among those who
formulated the program and propelled it forward were the then Prime Minister Mr Shimon Peres, the
then Finance Minister the late Yitzhak Modai, my friends the late Professors Michael Bruno, who
became Governor of the Bank of Israel, Eitan Berglas and Herbert Stein, and Emmanuel Sharon,
Professor Nissan Liviatan and many others.
For me, marking twenty years since the ESP closes an important circle, not only because since I
participated in it I have become the Governor of the Bank of Israel. It is because the reality in which
Israel's economy operates today is the outcome of the macroeconomic strategy that was launched
then and that has been developing constantly, not without difficulties and occasional disagreements,
right until the present. The Bank of Israel participated fully in the strategy, and more than once
provided the main motive force behind it, particularly in the 1990s when we moved from
foreignexchange control to free capital flows, from a fixed exchange rate to an exchange rate determined by
market forces, and from inflation at a level of 15 percent to 20 percent a year to price stability. For
these achievements we owe thanks to the previous Governors, Professor Jacob Frenkel and Dr David
Klein.
The government operates within a framework of long-term fiscal discipline the purpose of which is to
reduce the burden on the economy of debt, taxation and government expenditure. The public in
Israelhouseholds and the business sector-benefit from complete freedom in regard to foreign currency; the
economy is an open one in the areas of trade and capital movements; the capital market is developing
constantly, and the government has severely curtailed its involvement in it and in the economy in
general; and the Bank of Israel pursues an independent monetary policy-mainly due to the
NonMoney-Printing Law of 1985 which simply forbade the Bank to print money for the government's
budgetary requirements.
It is important to observe at this early point that the main target of that long-term strategy is the
achievement of sustained growth which we all wish for. It is the basis for improved welfare of the
whole population and for welfare policy that will deal with its weaker strata.
And indeed, Israel's economy achieved a growth rate of over 4 percent in 2004, and although the data
relating to real activity in 2005 are not unequivocal, it seems to us that growth for the year as a whole
will be between 3.5 percent and 4 percent. Employment data so far show an impressive improvement,
at least in the first four months of the year.
Are these accomplishments enough, and can we now take it easy? Obviously that is a rhetorical
question, the answer to which is a resounding "No!"
Many important challenges still confront us:
The main challenge is to continue to maintain the achievements that have been attained. Much work
has been put into reaching this situation and much energy invested in it over many years.
Relinquishing the accomplishments would soon take us back to where we were and make us start the
whole procedure over again. That is too dangerous a game to play, and we should not consider
playing it. One of the lessons I learned while at the IMF was that one can destroy in less than a year
an economic achievement for which one worked for more than a decade-a lesson applicable not only
in the field of economics. Now in particular, when the economy is stable and on a path of growth, we
must constantly examine what potential situations could harm or weaken it, and what we must do to
deal with them.
Underlying all the above is the continuation of the macroeconomic policy based on the one hand on
long-term fiscal policy, and on the other hand on monetary policy that acts directly to underpin price
stability and support financial stability.
The long-term path that the government decided upon-within the framework of the legislation that
determines the maximum real increase in government expenditure (1 percent a year) and the budget
deficit (up to 3 percent of GDP)-serves, together with the privatization policy, as bellwether to the
required fiscal policy. In this context, the tax program recently adopted by the government also
incorporates a component that supports a reduction of government debt. This fiscal arm of policy will
contribute to economic growth.
In the monetary area, it is essential that the Bank of Israel be able to continue acting, like other
modern central banks, to preserve price stability in the long run, in line with the government's decision.
Obviously I am referring to a new, up-to-date Bank of Israel Law. This is a vital issue to the Bank, and I
will revert to it in greater detail further on.
In addition to the macroeconomic strategy that I have described, the microeconomic sphere offers
challenges too, of no less importance. I will refer specifically to an area currently on the agenda of the
Knesset, and that is the reform of the financial markets, or the recommendations of the Bachar
Committee. The reform is aimed at a) reducing the concentration in the financial system and boosting
competition in the capital market, and b) lowering the chances of conflict of interests in the system.
The Bank of Israel supports this reform. It comes together with several other structural reforms and
instances of privatization that have taken place with the intention of giving households and the
business sector greater freedom and flexibility.
Alongside all the above, it is very important that we give attention to welfare policy. In the last few
years the Research Department of the Bank of Israel has invested considerable resources to
formulate recommendations in this field, and I intend this to continue. There is close cooperation with
the Prime Minister's Office and with the Ministry of Finance, but not only with them. It is clear to us all
that we must make a concentrated effort in the social area. Welfare policy must be focused, and
should act along two channels:
The first is to encourage people to go out to work, in other words, to raise the rate of participation in
the labor force, a rate which is lower in Israel than in the OECD countries, and to help those who are
working but earning too little to climb out of the poverty trap. The recommendation of the Bank of Israel
in this regard is a negative income tax, or what is known in the US as an Earned Income Tax Credit
(EITC).
The second is to give assistance to those in the population who are unable to participate in the labor
force, such as the elderly and the disabled.
The social issue leads us naturally to the question of education including technological education.
Education, which is available to all sections of the population, is important both from the aspect of
growth and from the aspect of welfare problems. With regard to growth, education is important
because a large part of growth must be based on increased productivity, on technological advance,
and on a rise in the human capital of labor force participants-an area in which Israel has a tremendous
advantage. It might be natural for an economist to speak of education in terms of productivity, but
education has an extra importance in that it offers equal opportunity to all sections of the population,
according to the individuals' abilities, to acquire skills that will help them to improve their situation.
Finally, I said that I would revert to the question of the Bank of Israel Law. Twenty years ago I thought
that the legal framework for central banks is not of such great importance. But after what happened
until the mid-1980s I understood just how important it was to enact the Non-Money-Printing Law as
part of the stabilization program. The fact is that a central-bank law affects the bank's ability to achieve
the objectives of monetary policy.
In essence, that is the reason why a new, modern Bank of Israel Law is of interest to each and every
one of us as citizens of this country.
In a spirit of mutual understanding, the Bank of Israel is actively cooperating with the Prime Minister,
the Minister of Finance and their offices to promote the legislation, and to close another circle that
started twenty years ago and that has taken long enough; it is clear that the time has come to bring
this matter to an end-we must remember that 8 years have passed since the excellent report of the
Levin Committee.
The following are the most important aspects:
First, the new law that we in the Bank of Israel propose clearly defines the independence required for
a central bank, similar to the situation in other developed countries, but it is apparent to us that
independence must go hand-in-hand with responsibility. The new law that we propose therefore also
incorporates a clear system of decision-making mechanisms, of internal and public controls, and of
reports to the government, the Knesset and the public.
Second, on the side of its responsibility, the proposed law clearly defines the Bank's objectives: 1)
maintaining price stability, according to the target set by the government, as the prime target; 2)
supporting the government's other economic goals, including growth and employment, without
harming price stability and the proper functioning of the financial system. This replaces the vagueness
in the current Law. The economic literature states that the central bank will not have independence in
its objectives, in other words, the law and the government determine the central bank's objectives.
Third, the proposed law grants the Bank full independence to use the instruments needed to achieve
its objectives. In the literature this is referred to as instrument independence.
Fourth, with regard to decision making, two new bodies are proposed-a monetary committee and an
administrative council. The monetary committee will make decisions in the field of monetary policy,
and will report accordingly to the public. It is proposed that the Governor will chair the committee,
which will have a majority of members from outside the Bank, who will be selected according to their
qualifications in the relevant economic area and free of conflict of interests.
The administrative council will authorize administrative issues such as the Bank's budget and staff
salaries, and will report accordingly to the public. In this council too members from outside the Bank
will constitute the majority; one of them will be the chairperson (not the Governor, who will be an
ordinary member). The members from outside the Bank of Israel will be selected according to their
qualifications in the business and administrative sphere, and will be free of conflict of interests.
Fifth, the proposed law defines a system of periodic reports to the government, the Knesset and the
public-annual, biannual, and quarterly-as well as a special report which the Governor will submit if the
Bank consistently deviates from the price-stability target defined by the government.
The question of the law, as I said above, is vital for the Bank of Israel so that it can operate in the
future, in the near future I hope, in a legal framework that will describe precisely the goals of monetary
policy, the areas of the Bank's responsibility, and the meaning of its independence. This is also
important as part of the integration of Israel's economy into the family of advance economies.
Thank you very much.