david klein : coping with the challenge to reduce poverty speech by mr david klein, governor of the bank of israel, at the imf / world bank annual meeting, dubai, 23 september 2003. * * * mr. chairman, mr. kohler, managing director of the imf, mr. wolfensohn, president of the world bank group distinguished governors, delegates, ladies and gentlemen, the world recognized the need to give priority to the global poverty problem, and expressed a wide consensus on this matter in the millennium development goals. let me devote my statement today to this subject, and say a few words on the challenges facing israel in its efforts to reduce poverty. we believe that poverty cannot be tackled effectively if policy is not focusing on growth. growth is not a sufficient condition for reduction of poverty, but it is, at one and the same time, the highway to raise the living standards of those who are able to work, and the provider of resources to support those who are unable to help themselves. we also believe that in order to realize its potential growth, the israeli economy - perhaps like some other small and medium - sized economies - has to be open to free movement of goods, services and capital, and to adhere to international standards of macro - economic management, including the standards for fiscal deficit and price stability. such a framework maximizes israel ’ s potential contribution to science and technology as a major vehicle of growth through international trade. however, this approach also requires to make our tax regime competitive with that of other countries, which necessarily means to commensurately reduce government expenditures to keep a lid on its debt. therefore, the macro economic framework constrains the room to handle the challenge of reducing poverty by just increasing welfare payments. when we come to formulate an alternative strategy, we rely on the experience and advice of the world bank and the imf and the policies of other countries, like those adopted by the european union. one fundamental element in our strategy consists of various reforms in the labor market leading to an increase in the ratio of employed persons in the working age population. this is one dimension in which we lag behind the developed world. i need not elaborate here on the significant relation between the rate of employment and the incidence of poverty. a second key element in our strategy is targeting of the policy to reduce poverty. like some other countries, we have a history of increasing welfare payments without making a distinction between those who are able, or unable, to work,

truly universal. procyclicality strictly speaking, procyclicality is a tendency of financial systems to fluctuate around a trend with the economic cycle. by extension, procyclicality can encompass all “ amplification mechanisms ” through which an initial shock results in wider movements in asset prices, credit flows, market liquidity, and, possibly, the real economy. our accounting and prudential regimes have increased procyclicality in recent years. in a mark to market environment, asset prices movements quickly translate into changes in the capital base of financial institutions. this, in turn, triggers additional demand for assets and a further increase in their prices. this kind of “ inverted demand curve ” ; where demand increases with prices, may create the conditions for deep and lasting financial instability. addressing procyclicality caused by the regulation itself is therefore a priority. the first line of defense against procyclicality should be the accounting framework. i strongly support the current focus on changing the accounting rules. more precisely, moving from an incurred loss model to a forward looking model is essential. we need a robust, auditable and straightforward provisioning system at the accounting level based on a forward looking model that would allow provisioning efforts commensurate with credit risks through time. this framework should also be simple, bearing in mind the ultimate objective of creating synergies between prudential and accounting standards. the basel committee is working on a very comprehensive approach, which is casted in its “ principles for revision of ias 39 ”. accounting standard setters have also been working hard. i firmly believe that two steps are required going forward. one is that the iasb should follow the principles by the basel committee. another is that the iasb and the fasb should adopt a common methodology regarding provisioning based on expected credit losses. this is a precondition to ensure that the g20 countries have convergent accounting systems. some of the procyclicality can also be trimmed through prudential regulation. efforts to make solvency ratios potentially less procyclical are welcome and should be pursued. in particular those efforts aimed at imposing a measure of risks “ through the cycle ” or “ downturn ” are useful. other options to take some of the procyclicality off through prudential standards include a fixed buffer, which would act as a capital conservation device. i see some limitations to such an option. it is hard