Prof. Rafi Melnik, president of Reichman University and a senior economist, announced yesterday that the May index had jumped 0.6% and inflation was at an annual rate of over 4%. The expected interest rate hikes are a one-time correction?
Let’s return to the basics: how do you see the state of the world economy, how did we get into this state, how do we get out of it, and what will be the bumps in the road?
“Let’s start with the fact that the situation today is that the interest rate in Israel and around the world is not suitable for the situation in the economy. If this is not corrected, we may degenerate into much higher inflation than we currently see.”
What does it mean that the interest rate is not appropriate for the state of the economy?
Let’s go back to inflation, why is it so scary?
“Inflation is a phenomenon of rising prices. It is not a one-time rise in prices for one product or another. And it is a very, very serious disease, a disease that affects all economic units in the economy. Especially the weaker sections, who do not know how to defend themselves against rising prices. “Once inflation erupts and prices rise at a high rate, resource allocation is hurt, and if inflation continues to rise, so is growth and productivity is hurt.
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“Former Fed Chairman Ben Bernanke said that if the war in Ukraine ends and the price of a barrel of oil falls below $ 100, we will be able to avoid a recession. The script is not reasonable in my eyes “
(Photo: Gilad Kvalarchik)
What can a central bank do?
“The central bank has several tools, but its main tool is the interest rate. Raising the interest rate reduces demand, and thus the rise in prices moderates or stops. Lowering interest rates increases demand, and drives the reverse process.”
So what is the concern, the bank can raise interest rates and curb inflation.
“The big concern is that the price increases we have now will become part of the psychology of economic units. When everyone thinks that price increases are going to continue and accelerate, it’s a situation we call ‘inflation expectations’, and everyone starts raising prices, and then a cycle is formed that breaks hard. “When there is a rise in prices and full employment, wage agreements are opened and wage increases begin that are very difficult to stop, these fuel prices and we enter a spin that is difficult to stop.”
How do you know what people’s expectations are?
“There are very good ways to measure expectations. An example from the capital market: examining the difference between the yield on indexed bonds and unlinked bonds. There are also financial forecasters. According to the data, we are not yet at the stage of high inflation expectations, long-term expectations are On the seam. ”
If it is so important to start fighting inflation in time, have interest rate hikes in Israel and the US started in time?
“There was a delay. It was possible to start operating a few months earlier, both in the United States and in Israel. But I do not blame them. There was a very unique situation here, bad luck: a global epidemic broke out and unemployment rates increased dramatically, the central bank had to increase liquidity to deal with the corona, and I supported that. But the plague weakened and the economy returned very quickly, much faster than everyone expected, to full employment. And in this surprising return to routine, the war in Ukraine began and land price increases in food and energy, which is against the background of all the liquidity that was in the markets. I think it is possible to understand why they did not act in time, this is really a unique situation. ”
What about the functioning of central banks?
“Raising interest rates sends the signal to the markets: ‘We are aware of the problem and address it’, and the hope is that it will reverse inflation and prevent it from rolling into expectations. But we must also dictate a very transparent, very understandable and very credible policy. “The interest rate for the economic reality created in the world. Get ready for it and react.”
Governor Amir Yaron did not convey this message to your liking?
“The public still does not quite understand this, and it is important that the public understands this. I think at least Yaron’s performance at the last conference of the Aharon Institute that took place last week at Reichman University did not convey the right message.”
So maybe you’ll sharpen up, what do you mean when you say a credible and transparent policy?
“If a minister comes out with a credible plan to curb rising real estate prices, then the public will act accordingly and reduce demand, but if the plan is not perceived as credible, then real estate prices will continue to rise. It is the same here. The central bank should say what it plans to do “And do just that. In professional parlance this term is called ‘Forward Guidance’, pre-intended.”
Maybe the bank is not clear what exactly it should do?
“No, there are no hesitations in the Monetary Committee now. The Bank certainly knows what it needs to do. But it needs to convey this message to the general public, this is a time when the Monetary Committee and its chairman – the Governor – must demonstrate leadership on economic issues.” The government in its ability to deal with inflation on its part. “
But raising interest rates has the risk of hurting the economy.
“If interest rates do not rise, then inflation will hit everyone very hard; if you do not prevent this, the harm will be on everyone. And in preventing that, the profit will be for everyone. It is true that raising interest rates works to curb demand, but that is exactly the way to control inflation.” .
Do you think we’ll go into recession?
“There is definitely a chance of a recession, it is not an imaginary scenario, especially since we are a very small economy and very open and very affected by what is happening in the world. If there is a recession in the world – then we will have a recession “Former Fed official Ben Bernanke says that in the most optimistic scenario, that the war in Ukraine will end very soon and oil prices fall below $ 100, so there is a chance of a ‘soft landing’. The question is what probability we give to this scenario, I give it a low probability.”
So raising interest rates will lead to slowdown, recession and unemployment?
“We need to act in accordance with what is happening and not in accordance with what may happen in a hypothetical case. Currently, the economy is growing with zero unemployment and huge demand in the labor market.”
Finance Minister Avigdor Lieberman said this week about rental prices that the data do not show an increase in rental prices, and to address rental prices he must wait for updated data.
“There is a very big danger in this wait because if you squander the right time, then the action required afterwards is much more difficult. In general, inflation policy should always precede the trend, look ahead. When inflation was very high in the 1980s, then central banks “They went to the supermarket themselves and checked prices, we are not there yet.”
What can an individual do to protect themselves from inflation?
“The ordinary citizen has very few tools to deal with it. Inflation is simply a disease that harms the public, so it is important to take control of it and not let it raise its head.”
We mentioned rental prices, you were a member of the housing team on the Trachtenberg Committee, are you watching a social protest again in the summer?
“I do not know. I do not think the situation repeats itself. In terms of housing, we are not in a better position than in 2011. But in other economic terms we are better off. The standard of living, the level of employment, growth, high-tech and the exchange rate.”
We see that high-tech, the locomotive of growth in Israel, is particularly sensitive to changes in interest rates, should this worry us?
“In an era of zero interest rates, it was very difficult to impossible to price the true value of high-tech companies, so what happened there was that liquidity and relative profitability pushed investors to invest, and stock prices rose beyond the real value of companies. Now that interest rates start to rise “We are beginning to ask ourselves what the real value of these companies is, so we are seeing very sharp declines in all the high-tech industries, and we have not reached the end, because we do not know how much stock a startup has actually issued. We are in the middle of an unfinished search process.”
Have we developed an over-dependence on high-tech?
“I think we have developed a relative advantage in the high-tech sector compared to what is happening in the world. Therefore, there is a situation where it will be difficult for these companies in the next two years to raise the funds they raised in the past easily. But I do not see dramatic damage “.