May 20--Governor of the Bank of Israel Dr. Karnit Flug does not support a "an exchange rate level" for the shekel-dollar exchange rate, even as the exchange rate has fallen to a level last seen in August 2011. At the Israel Economic Association's Annual Conference, she said that most countries do not set an exchange rate target for their currencies.
"Contrary to the concept that prevailed in the past that the stable foreign exchange policy regimes were the ones at the extremes -- a fixed exchange rate or a completely floating exchange rate- the recognition grew after the crisis that a regime of a mobile exchange rate with occasional intervention, referred to as "managed float", may have the potential to support policy objectives, provided that there is no declared exchange rate level that could constitute a 'soft target for speculators.' Thus, the managed float became the most common exchange rate regime in the emerging markets, while the 'free float' regime is in place in less than 8% of these economies," she said.
Instead of proposing a minimum shekel-dollar exchange rate, Flug spoke about restricting capital flows, a subject that the Ministry of Finance is supposed, but refuses, to deal with, such as by levying a tax on capital flows. "There has been a change in tune about restricting capital flows. Once, the discussion was about capital market oversight; now it is about managing capital flows. Once, capital flows were eased and there was liberalization; now capital flows are being restricted, and the number of restrictions since the crisis has only grown.
"The organizations that once strongly supported sweeping liberalization of the foreign currency market accept restrictions as legitimate and creative tools to prevent capital flows that are liable cause volatility, such as massive appreciation of the local currency. What is very important is understand that restrictions on capital flows cannot be an alternative to proper macroeconomic policy."
As for the role of central banks, Flug said, "In the years prior to the crisis, most of the central banks would meet periodically and make decisions regarding the monetary interest rate, taking care to maintain inflation within the target range. Some also took into account considerations of supporting growth. This more or less summed up the role of monetary policy. Since the crisis, the central banks' concept of their roles and their policy tools underwent a dramatic change. The change in concept regarding the targets and functions of central banking can be summarized in a quote from an updated policy paper by the International Monetary Fund: "Long-term price stability remains a primary objective and central bank independence a critical ingredient to achieve it. Other intermediate objectives (such as financial and external stability) may have to play a greater role than in the past to guarantee macroeconomic stability. And, this expanded mandate requires either new tools or the acceptance of new trade-offs."
Flug added, "There are two components to the conceptual framework proposed by the International Monetary Fund for non-conventional monetary policy. The first is additional monetary accommodation in situations where the interest rate is near-zero, which is reflected in asset purchases, mainly the purchase of bonds in the secondary market, and forward guidance that mainly takes the form of expressing a commitment that accommodative policy will continue over time. The second is the rehabilitation of the functioning of the financial markets by providing liquidity as a loan of last resort to non-bank entities as well, and by purchasing private and public assets of various entities, in order to prevent a downward price spiral or market paralysis."
As for Israel's foreign currency reserves, which have risen to near $90 billion due to the Bank of Israel's dollar purchasing policy, Flug said, "A number of countries that had large foreign exchange reserves sold significant volumes of foreign exchange when capital flows changed direction, and thereby prevented a serious shock to the exchange rate that could have caused a financial shock."
(c)2014 the Globes (Tel Aviv, Israel)
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