Israel dodged the recession that hit most of the world last decade, partly because it never had an extreme housing boom and bust. Much of the credit for that stability went to Stanley Fischer, the Zambian-born economist who headed Israel’s central bank from 2005 through 2013 and is now No. 2 at the Federal Reserve in the U.S.
But Fischer made clear today in a speech in Stockholm that he doesn’t have a magic needle for deflating housing bubbles. Israel’s jump in housing prices wasn’t so much prevented as postponed a few years. Robert Shiller, the Nobel prize-winning Yale University economist, said in January that Israel’s housing market “sounds like a bubble,” noting that Fischer “tried to restrain it but failed.” Home prices are up more than 80 percent since 2007 and rose 8.8 percent in the 12 months ended in May.
In Israel, almost all housing finance is provided by banks, and the Bank of Israel is the banks’ supervisor, giving it “considerable power over housing finance,” Fischer said in his first major policy address since being sworn in as the Fed’s vice chair on June 16. Starting in 2010, he said, the Bank of Israel adopted several measures to “address rapidly rising house prices.”
The one that worked best, he said, was weakening the link between mortgage rates and short-term interest rates. Only one-third of any housing finance package can be indexed to the short-term rate controlled by the Bank of Israel. The remainder has to be linked to five-year interest rates, which are usually higher. Fischer said that change “substantially raised the cost of housing finance and was the most successful of the measures.”
The Bank of Israel also limited loan-to-value and payment-to-income rates. Fischer said those measures were “moderately successful.” A third set of changes intended to increase the safety cushion at banks “appeared to have little impact in practice,” he said in his speech in Stockholm, according to the prepared remarks.
Fischer devoted only two paragraphs to Israel in a wide-ranging speech that covered, among other topics, his optimistic outlook for productivity growth. Countering economists who foresee an era of low growth in productivity, he said, “I for one continue to be amazed at the potential for improving the quality of the lives of most people in the world that the IT [information technology] explosion has already revealed.” He speculated that recent weakness could be an aftereffect of the crisis, holding back “pent-up” improvement. And he said that in the developing world there is scope for huge improvement in productivity “reflecting technological catch-up, infrastructure investment, and the potential for human capital increases due to improvements in education and nutrition, and the incorporation and inclusion of women into the labor force.”