stanley fischer : the global financial crisis – challenges confronting israel address by professor stanley fischer, governor of the bank of israel, to the annual conference of the institute for national security studies, tel aviv, 23 december 2008. * * * for more than a year the world has been confronting one of the worst financial crises in over seventy years. this crisis has two components : the first, financial, and the second, real – i. e., a significant slowdown, and possibly even a global recession. both the financial and real effects of the global financial crisis on israel's economy are clearly evident. i would like to stress, however, that israel's state at the outbreak of the crisis was more favorable than that in most other countries. on the financial side the crisis is reflected in israel not by problems in the banking system, as is the case in the advanced economies, but mainly by the fall in prices of shares and corporate bonds. at the same time, on the real side the rate of growth declined to 2. 3 percent ( annual rate ) in the third quarter, and it is expected that the significant slowdown in israel's growth rate will continue ; according to the bank of israel forecast, the rate of growth will slow further in 2009 to 1. 5 percent, or even lower in one or two quarters. israel's relatively favorable situation at the outbreak of the crisis was due to responsible and credible fiscal and monetary policies, the economy's low foreign currency exposure, the surplus in the current account of the balance of payments, the relatively high level of the foreign exchange reserves, and, worthy of special emphasis, the strength of the banking system. now, however, three months after the further intensification of the crisis, the challenges confronting the policymakers on both the real side and the financial side have become much more difficult. the policymakers face the task of maintaining the economy's relatively favorable position and taking advantage of it to deal with the new situation. to that purpose it is essential that they introduce the measures needed to ensure that the economy emerges from the period of slowdown strengthened, and with the ability to return to the path of rapid and sustained growth. all this, despite the forthcoming elections and the fact that the 2009 budget has not been approved yet. at this stage the bank of israel is taking the following steps within the realm of its responsibility : 1. it is conducting an active interest rate policy intended to strengthen the economy's ability to handle

importance, their failure costs would be so high. thus, at present, tbtf financial institutions are not obliged to bear the full extent of the risk they assume. in the event of problems they can pass on the risk to the general public. this is a fundamental contradiction to the basic principles of a properly functioning market economy. in order to contain these market imperfections the guiding principle should be – do what is necessary, but no more than is necessary! consequently, the measures to be taken need to contribute to stability without obstructing key welfare - enhancing functions of the financial system. in particular, it is important that the measures are first and foremost designed to correct false incentives and to guide them in the right direction so that, first, unprofitable financial institutions leave the market of their own accord and, second, potential losses are borne by these institutions themselves, and not by the state. consequently, in my opinion, measures such as a ban on proprietary trading or the introduction of a narrow banking system, that intervene too strongly in banks ’ business models, are not very suitable. such measures neither target the objective nor are they in line with the basic principles of the market economy. with regard to the tbtf issue, this principle has prompted the committee of experts appointed by the swiss government to draw up proposals including the creation of incentives for banks to become less systemically important overall, thereby reducing potential costs for the economy. at the same time, the committee of experts ’ proposal will allow for improved resolution in the event that insolvency appears imminent, and this will significantly alleviate the tbtf problem. are the measures “ structural ”? a second criterion is that the measures should not just address the specific circumstances of the most recent crisis. in other words, fighting the last war will not win the next one. at the same time, the lessons of history show us that certain basic mechanisms repeat themselves in every crisis. consequently, it is very important that we recognise these general patterns and include them in regulatory considerations in order to improve our crisis prevention. this prevention is geared to establishing instruments whose effects are as broad - based as possible, in other words, instruments that are independent of the specific causes that lead to crises. one general pattern in financial crises is that market and investor confidence plays a central role. 2 in general, when a bubble is being formed, soaring price trends are initially explained in “ rational ” terms. in the recent crisis, for instance, developments in the us housing