WHERE THE WIND BLOWS - 02-Aug-96

WHERE THE WIND BLOWS

(Article by Judy Maltz, "Ha'aretz", Aug 2, 1996, p.C1)

NETANYAHU'S SUPPORT WHICH WAS NOT SURPRISING, OF FRENKEL'S REDUCTION IN THE INTEREST RATES, AGAIN EXPRESSES THE CHANGING POWER STRUCTURE BETWEEN THE THREE LEADING ARCHITECTS OF ECONOMIC POLICY.

Last week, when Bank of Israel Governor Jacob Frenkel announced his decision to lower the interest rate by 0.7%, he was attacked from all directions. One side argued that this was only a symbolic reduction that would contribute nothing to an economic recovery. The other side, meanwhile, argued that the Governor had conceded to pressure, and that there was no reason to lower interest rates.

Only one man publicly offered his support for Frenkel. In an unusual step, Prime Minister Benjamin Netanyahu issued a statement stressing the importance of reducing inflation, and expressing his "full confidence" in the Governor.

But even more important than the actual statement was its timing. Netanyahu did not express "full confidence" in Frenkel a week earlier, or even two weeks earlier at the Caesarea Conference where the Governor stood alone against a broad front of opponents to his policy. The Prime Minister waited until Frenkel delivered the goods. And there can be no doubt that Netanyahu's words of support would not have found public expression had Frenkel decided to, for example, raise interest rates or not to lower them.

Even if Netanyahu had not asked Frenkel to lower rates, there is no doubt that, in his own view, rates were too high. The Governor understood, searched for, and found a number of "encouraging" indicators which allowed for a certain reduction.

This week's events again demonstrate the changes that have occurred in the power relations between the three leading architects of Israel's economic policy Prime Minister Netanyahu, Finance Minister Meridor, and Bank of Israel Governor Jacob Frenkel. Two months ago, before the Government was formed, Netanyahu wanted Frenkel as his finance minister but he was ultimately forced to surrender to party pressure, and appoint Dan Meridor to the post. Despite this fact, it was then very clear that, even at the Bank of Israel, Frenkel would have an influence in the creation of policy owing to his close ties with the Prime Minister. Netanyahu and Frenkel would make policy, it was then said, and Meridor would implement it.

But these were the power relations before the Prime Minister convened his Cabinet for its first meeting, when he learned that what is economically correct is not always politically correct. And these were also the power relations before the Prime Minister learned that high interest rates occasionally have harsh side-effects. Since then, Netanyahu has slowly begun to distance himself from the Governor and move in the direction of the Finance Minister.

One who looks at newspaper clippings since the formation of the Netanyahu Government will find it difficult to locate a critical word by Meridor against the Governor. As opposed to his predecessor, Avraham Shochat, Meridor is careful not to publically attack Frenkel. This may be part of his "official" character, or because of his personal feelings for the Bank of Israel (where his wife worked). And yet, even if he has not attacked the Governor in the press, one cannot conclude that he agrees with his policy.

The disputes between Meridor and Frenkel are no less harsh than those that were between Shochat and Frenkel and there are those who say that the former are even more serious.

Since the establishment of the Government, differences have surfaced between Meridor and Frenkel in three principle areas in each of which the Prime Minister has been inclined toward the Finance Ministry. The first disagreement erupted on the size of the cuts to the State Budget. The Finance Ministry proposed cuts totalling NIS 4.9 billion in the 1997 budget, and cuts of NIS 350 million in budget for 1996. The Governor wanted cuts of NIS 6.5 billion in 1997, and of NIS 2-3 billion in 1996. Netanyahu took the side of the Finance Ministry.

The second dispute emerged in the area of interest rate policy. Until one week ago, Frenkel would not consider the possibility of lowering interest rates, in the wake of large deviations from both the inflation target and the planned budget deficit for 1996. Meanwhile, the Finance Ministry argued that because high interest rates were the main reason for the crisis in the capital market, the public's massive withdrawal from the provident funds, and the continuing decline in the dollar exchange rate there was an urgent need for correction. Although interest rate policy is under the exclusive purview of the Bank of Israel, as the Finance Minister bothers to note, the Prime Minister allowed Frenkel to understand that interest rates were bloated. The end of the story is public knowledge.

The third argument involved the determination of inflation targets. The Governor's position was that a multi-year target (with quantitative, yearly objectives) for reducing inflation must be determined, with the goal of reducing inflation to levels similar to those of industrialized countries until the year 2001.

Frenkel twice attempted to pass a Cabinet decision on the matter, and prepared two alternatives to this end. According to the first alternative, the inflation target would stand at be 7%-9% in 1997, and drop to 3%-5% in 2001. The second alternative called for an inflation target of 6%-9% in 1997, dropping to 2%-5% by 2001.

Meridor was enraged at Frenkel, whom he accused of trying to circumvent him, since the proposals were neither discussed with nor agreed to by the Finance Ministry. Moreover, the Finance Ministry's position is that specific targets should not be fixed, and that the Government should suffice with a declaration of its intent to reduce inflation to levels existing in the industrialized world by the next decade. Netanyahu again sided with the Finance Ministry, preventing any discussion on Frenkel's ideas on the subject.

This week, the Prime Minister did Frenkel the favor of supporting his decision to adopt the strategy of determining a multi-year inflation target. Still, Netanyahu's office said that a decision has yet to be made on determining quantitative inflation targets; in other words, the battle between the Finance Ministry and the Bank of Israel has yet be be resolved.

To a large extent, the arguments between Frenkel and Meridor are typical of those between all central bank governors and finance ministers. The central bank governor makes inflation reduction his top priority and, in this respect, Frenkel is no different from the rest of his colleagues around the world although he tends to say that achieving price stability is not "everything," but rather a prerequisite for achieving other important targets.

Meridor, on the other hand, will say that reducing inflation is an important target perhaps even a very important one but there are also other targets, which hinge upon the price of reducing inflation.