Bank of Israel Gov. Llein Before Knesset Finance Committee
(Communicated by Bank of Israel Spokesman)

Jerusalem, January 19, 2000

Following are comments made by Bank of Israel Governor David Klein to the Knesset Finance Committee today (Wednesday, 19.1.2000):

The main challenge now before us in monetary policy is to consolidate the significant achievement of lowering inflation – including imparting the norms of decision-making in a low inflationary environment. For some time now, interest rates have been gradually declining, with the objective being to maintain the current inflationary environment. In the framework of this interest rate policy, it is worthwhile to take into account expected developments in global interest rates – which affect the reduction in the difference between interest rates in Israel and abroad – and changing trends in financial assets portfolios held by the public, both Israeli citizens and foreign residents. It should be noted in this context that the rise in the weight of unlinked shekel assets and stocks, at the expense of assets linked to either exchange rates or the CoL index reflects increasing public trust in the policy to reduce inflation and maintain it at a low level.

The Bank of Israel’s interest rate policy is not only expressed by the monthly decision on the nominal interest rate, but mainly by the way the public derives its future, longer term, interest rate decisions based on that rate. Interest rate policy should transmit to the public a message that the road to reducing interest rates must be consistent with the inflation target set by the government.

Israel’s inflation environment is closer than ever to that defined as price stability, i.e. the level of inflation current in the developed world. Israel’s rate of inflation must be comparable to inflation in developed economies. This is crucial for a successful integration into the global economy and is a condition for sustained growth.

The evaluation of inflation cannot be based on a calendar period, but has to be based on an analysis of long-term inflationary trends. 1999 – which concluded with a low rate of inflation of 1.3% resulting from the negative indices in the first half of the year – and 1995, which had a rate of inflation of 8% and an annual rate of 15% in the second half of that year, demonstrate this point well.

It is important that the government’s inflation target be a multi-year target, especially given the fact that the global financial markets by their very nature may undergo very rapid and unexpected changes affecting local prices. A system of multi-year inflation targets would not require drastic increases in interest rates to guarantee stability caused by sudden sharp price increases such as those that occurred in the last months of 1998, as would be necessary under an annual inflation target. Setting a two-year inflation target by the government is an important step in this direction. At the moment, it is important that the target for the coming two years be set by the second half of the year in order to allow greater flexibility in the management of monetary policy.

The Bank of Israel’s monetary committee would be important on the condition that it is anchored in the amendments to the central bank law based on global norms as recommended by the Levin Committee. Any partial legislation that deals with the monetary committee only would harm the Bank of Israel’s ability to function. Therefore, the new Bank of Israel Law must include the four components recommended by the Levin Committee – and which characterize central bank laws across the world – as a single composite act, as the Committee recommended. The components are: Defining the Bank of Israel’s main objective as achieving and maintaining long-term price stability; increasing the Bank’s transparency and reporting to the government, Knesset and public; establishing a monetary committee headed by the governor and whose members are experienced professionals from the relevant fields, independent and without conflicts of interest and whose full and sole responsibility is to the Bank of Israel’s targets.