risk outcomes ; compensation payout schedules must be sensitive to the time horizon of risks ; and the mix of cash, equity and other forms of compensation must be consistent with risk alignment. just three comments : first, it is extremely difficult to line up pay with incentives and performance, but it is critical that companies try to do better. second, the fact that individuals in effect have limited liability creates an asymmetry that encourages excessive risk - taking whatever the form in which conditional compensation might be paid. third, after the disasters of the last year, and the large costs of government intervention, the financial sector needs to regain the confidence of the public, and returning to previous modes and levels of compensation as if nothing has happened is not the way to achieve that goal. 19 the current discussion of corporate governance places much of the responsibility for achieving better performance on corporate boards. but we should not exaggerate what they and the regulators can do, for both lack the full - time immersion in the problems of the company that company management has. with regard to risk management and to compensation, and to corporate governance more generally, we need to look to firm management at least as much as to corporate boards and regulation to get it right. ii. the role of the central bank this was not a normal recession, and nor were the central banking policies used to combat it. the fed and other leading central banks played an extremely activist role in responding to the crisis, particularly in their interventions in asset markets. the question is whether central bank actions in this crisis were appropriate for crisis response, and whether the innovative policies we have seen in the last year will lead to longer - term changes in central banking doctrine and behavior. liquidity trap and quantitative and credit easing. the zero interest rate policy of the bank of japan in the 1990s was accompanied by a policy of quantitative easing ( qe ). the simplest notion of quantitative easing is that the central bank purchases assets in order to increase the monetary base, or a broader aggregate. in the present crisis, as the interest rate came close to its zero lower bound 20 in the us, japan, the euro area, the uk, canada, israel and other countries, central banks began policies of quantitative easing, via asset purchases. growth rates of various definitions of money have been impressive in many countries, with the growth rates of the monetary aggregates closest to the money base being highest – for instance, in the israeli case the growth rate of m1 over the past 12 months has been 56

oecd, although there are countries ( france, denmark, italy, and sweden ) where it is higher than ours. distortions in the taxation of financial income despite what was said above, the main problem in israel is not so much the total tax burden as the composition of tax revenues. among the numerous subjects requiring attention in this regard ( such as the sharp rise in tax rates on labor income as the latter increases, with the top tax bracket applying at a relatively low level of income ; the heavy burden of indirect taxes ; low taxation on capital ), we will concentrate here on just one, taxation of interest income of individuals and mutual funds. the current situation suffers from the following distortions : • local - currency deposits are tax exempt ; foreign - currency deposits in israel are taxed. • savings schemes are exempt ; tradable government and private indexed bonds are taxed. • unindexed government bonds are tax free, while similar private bonds are taxed. the tax, where applicable, is 35 percent, and in some cases higher. there is thus a very grave distortion here. this situation causes serious damage to the functioning of the financial markets in the following ways : • it obliges the business sector to depend on banks as almost the sole source of finance in israel, and does not enable it to develop alternatives via the capital market. similarly it creates a preference among households for savings via banks. the tax system thus strengthens the banks ’ monopolistic hold over financial intermediation in israel. • changes in the composition of the assets portfolio, i. e., switching between local - currency and foreign - currency assets, is affected by considerations of taxes which were introduced in a period when no nis / foreign - currency market existed in israel, and which needlessly affect the exchange - rate appropriate for israel at any time. in this way one of the pillars supporting israel ’ s economic growth - foreign trade - is undermined. • the tradability of the government bond market is adversely affected as tax rules effectively exclude households from this market - another blow to the infrastructure of any advanced capital market. • the tax distortions deter foreign financial institutions from developing services for israelis, thus also impairing the financial markets in israel. these all undermine financial stability and the economy ’ s ability to withstand financial shocks, whether caused domestically or from abroad, placing an open economy such as israel ’ s at a great disadvantage. the opportunity to iron out these distortion