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Fischer's mission

The former IMF deputy is no stranger to policymaking or Israel. Here's how he hopes to make his mark as Bank of Israel governor.

Stanley Fischer got his first taste of policymaking in 1983 when George Shultz, then­secretary of State, called on him and other academics for advice on lifting Israel out of a dire economic crisis. The U.S.'s closest ally in the Middle East was reeling from triple-digit inflation, a gaping budget deficit and plunging foreign exchange reserves. Without Washington's backing, the country would likely have gone to the wall like Mexico, which had defaulted on its debt the year before.

Working with Herbert Stein, a former chairman of the U.S. Council of Economic Advisers under presidents Nixon and Ford, Fischer, a professor of economics at the Massachusetts Institute of Technology, had no trouble coming up with recommendations. His prescription was an early example of the neoliberal advice that would come to be known as the Washington consensus when Fischer served as the No. 2 official at the International Monetary Fund in the late 1990s: Slash the budget deficit, make the central bank independent, tighten monetary policy and devalue the currency to boost trade. Persuading Israeli politicians to adopt such painful measures wasn't easy, however. The cabinet of then­prime minister Shimon Peres approved the landmark economic stabilization program by a one-vote margin on July 1, 1985, only after intense U.S. lobbying and the promise of an extra $1.5 billion in U.S. aid.

The program proved remarkably successful, slashing inflation from a peak of 450 percent to 20 percent in one year. The episode also taught Fischer a vital lesson: Economic advisers need to develop close ties with politicians to persuade them to back tough economic policies, something he tried to do -- not always with success -- at the Fund.

"The way you sold an IMF program most effectively was to try to understand what was in politicians' minds," he tells Institutional Investor. "And you built trust by being very frank and not being very aggressive."

Today, Fischer is back at the nexus of economics and politics and applying those hard-earned lessons in Israel once again. The 61-year-old economist took the post of governor of the Bank of Israel in May, giving up a lucrative job as vice chairman of Citigroup to move to a country where he enjoys deep cultural, academic and policymaking ties.

"It's a chance to advise the Israeli Finance ministers," he explains, relaxing on a sofa in his office at the central bank's Tel Aviv branch, near the stock exchange. "Whether they liked it or not, I've been advising them for 25 years. I've been friendly with Bank of Israel governors for 25 years, given lots of advice. Now I want to do something myself."

Israel needs Fischer's experience and steadying influence now more than ever. The resignation last month of Finance Minister Benjamin Netanyahu, who hired Fischer and had been leading a program of economic reforms, highlights the risks posed by Israel's volatile political and security situation. The country's benchmark TA-25 stock market index dropped 5.2 percent, its worst decline in more than three years, on the day that Netanyahu announced he was quitting to protest Israel's withdrawal from the Gaza Strip. Late last month Netanyahu, who served as prime minister from 1996 to '99, announced he would challenge Prime Minister Ariel Sharon for the leadership of the right-wing Likud Party. If he wins the contest, which is expected to be held late this year, political analysts believe the coalition government of Likud and the left-wing Labor Party would collapse, forcing an early parliamentary election.

Sharon promptly named Industry and Trade Minister Ehud Olmert, a close ally and vice prime minister, as interim Finance minister. He also reassured Fischer that the government would maintain its economic policies and stick with the tight 2006 draft budget that Netanyahu had unveiled a few weeks earlier. The proposed budget, supported by Fischer, was designed to limit the growth of government spending and reduce the deficit to 3 percent of gross domestic product in 2006 from an estimated 3.4 percent this year and 3.9 percent last. The cabinet approved the proposal just days after Netanyahu's resignation, but many analysts believe the possibility of early elections (ahead of the scheduled November 2006 date) will forestall parliamentary approval. Labor, meanwhile, has stepped up its criticism of the government's economic policies.

Fischer can wield considerable clout amid the political turmoil thanks to his reputation and because Israel -- alone among countries -- assigns its central bank chief a formal role as economic adviser to the government. "In the short term Netanyahu's resignation strengthens Fischer, because Olmert will need as much support as possible in his economic policies," says Eytan Sheshinski, an economist at Jerusalem's Hebrew University.

The Bank of Israel has cast doubt on the government's ability to achieve its objectives. The bank's first-half inflation report, issued in July, cited the risks that spending on the Gaza withdrawal could exceed the budgeted 8 billion shekels ($1.8 billion), while security concerns could cause growth to fall short of the government's forecast of 3.9 percent this year. Growth rebounded to 4.3 percent in 2004, aided by a sharp drop in terror attacks, but remains below the 5.2 percent rate Israel averaged in the 1990s, when the technology boom and a surge in immigration from the former Soviet Union fueled the economy.

Ironically, given Israel's history of high inflation, Fischer's chief monetary challenge is to nudge inflation up modestly. The consumer price index rose by just 0.3 percent in the 12 months ended in June, below the government's target range of 1 to 3 percent, even though the central bank's main short-term lending rate stands at an all-time low of 3.5 percent. The central bank predicted in its July report that inflation would move within the target range over the next year, assuming continued economic growth, a moderate decline in the shekel and market expectations for an interest rate increase of as much as 1 percentage point. Fischer's predecessor as governor, David Klein, was criticized by the government for cutting rates too slowly during Israel's worst recession, in 2001 and 2002, when the renewed Palestinian intifada combined with the technology collapse to cause the economy to contract by 0.9 percent and 0.7 percent, respectively.

"For Israel, getting Stan is a very positive development," says Robert Rubin, chairman of Citigroup's executive committee and a former U.S. Treasury secretary who worked actively with Fischer to stem financial crises in Mexico, Asia and Russia in the mid- to late '90s. "An economic policymaker has to be conversant with economics conceptually, and Stan is overwhelming in that respect. He also has to have a feel for markets and for business and for how decisions get made in an economic environment by the participants, and Stan has that as well."

Fischer, an African-born Jew and naturalized U.S. citizen, had been negotiating with Netanyahu over legal changes that would entrench the central bank's independence by defining its primary goal as price stability and creating a monetary policy council to set interest rates, a power currently wielded by the governor alone. The idea of modifying the 51-year-old Bank of Israel law enjoys widespread support, including that of Prime Minister Sharon. But the political uncertainties stemming from the Gaza withdrawal cloud prospects that the government can push an amendment through Parliament.

The central banker had also teamed up with Netanyahu to pass a new law to shake up Israel's banking industry. The measure, approved by Parliament in July, will force Bank Hapoalim and Bank Leumi Le-Israel, the industry's dominant players, to sell their provident funds within three years and their mutual fund units within four years. Smaller banks will have up to eight years to divest their funds businesses, with foreign banks and Israeli insurers the likely buyers. Fischer believes the change will break up excessive concentration in the banking industry, promote competition and spur the growth of a vibrant capital market.

Fischer also is drafting a five-year proposal, likely to be unveiled this month, for combating poverty and unemployment. The proposal is expected to include U.S.-style earned-income-tax credits designed to get people off welfare by making low-paid work more attractive. A recent study by the central bank's research department concluded that such tax credits could reduce the ranks of the working poor by 18 percent, at a cost to the government of IS1.3 billion a year. Sharon and Olmert have expressed support for the idea, and a government committee is expected to produce a concrete plan in coming months.

The Labor Party has been critical of Netanyahu's reforms, however, contending that his cutbacks in welfare spending and reductions in income taxes have worsened poverty and widened the gap between rich and poor. Labor wants to increase the deficit target to 3.5 percent to allow for greater social spending. Even Olmert has promised new antipoverty programs, although he insists that he will stick within existing deficit restraints.

"It could undoubtedly be an obstacle for Fischer in an election year in situations where the government will want to spend more and Fischer will want it to stay within its budget plans," says Haim Ben-Shahar, an economist and a former president of Tel Aviv University. "Also, if there is a third intifada, that will slow economic growth."

Fischer's five-year plan is expected to propose developing economic relations with neighboring governments, including the Palestinian Authority, Egypt and Jordan, aides say. He is a staunch supporter of the Israeli-Palestinian peace process and believes a lasting agreement could lift Israel's potential growth rate to 5 to 6 percent a year by boosting tourism and foreign direct investment and fostering trade within the region. In 1993, Fischer cochaired a group of Israeli, Jordanian and Palestinian economists that drafted a plan calling for a free-trade agreement among the three countries, the establishment of a regional development bank and permission for at least 100,000 Palestinians to work in Israel (about 28,000 do so today). That plan was never adopted, as Israel and the Palestinians failed to reach the permanent settlement envisioned in the Oslo Accords, but the relatively smooth withdrawal from Gaza has revived peace hopes.

"If we want the Palestinians to prosper, then we should try to foster economic relations," Fischer tells II. "My main job is in the Israeli economy, and if I can have any influence on what I think will be the right direction, as long as I'm talking about economics, I'll say what I think. I can't make judgments on the security issue, nor should I."

Jacob Frenkel, who served as central bank governor under five prime ministers and seven Finance ministers from 1991 to 2000 and today is vice chairman of American International Group, holds similar views about the peace process -- and about the central bank's lack of authority on the issue. He believes Fischer will be "sufficiently sensitive and careful not to drag the Bank of Israel and the governorship into areas that are squarely within the political debates" unless they have a direct impact on the economy.

Vice Prime Minister Peres, the 82-year-old Labor leader who twice served as prime minister, suggests that Fischer could contribute to the peace process by advising the government on economic relations with the Palestinians. "At the end of the day, problems around the world today could be solved with modern economic tools," he says in an interview.

Fischer knows several senior Palestinian officials from his IMF days. Salam Fayyad, the Palestinian Finance minister, worked under Fischer as the IMF's first representative to the Palestinian Authority, from 1996 to 2001. George Abed, the head of the Palestine Monetary Authority -- the precursor to a future central bank -- was deputy director of the IMF's fiscal affairs department under Fischer and later director of the Fund's Middle Eastern department. Jihad Alwazir, the deputy Finance minister, says Fischer could be influential in enabling more Palestinians to work in Israel, a step that would help alleviate an unemployment rate that reaches 60 percent in some areas of the Gaza Strip, and facilitating the movement of goods between the West Bank and Gaza.

"I think he can play a very positive role in terms of having access to Palestinian as well as Israeli leaders," Alwazir tells II. "We would want him to help improve the economic relationship between us and Israel and ensure that Israeli economic policies vis-à-vis the Palestinian side remain consistent."

Fischer's appointment caught many in Israel by surprise. He had turned down an offer to become president of the New York Federal Reserve in 2003. That same year he responded with a curt "no thanks" when asked by the Israeli newspaper Yediot Aharonot if he would accept the Bank of Israel governorship. But when Netanyahu rang him while Fischer was vacationing in the Caribbean late last year, he proved receptive. He had been reading an English translation of Amos Oz's A Tale of Love and Darkness, a memoir about growing up in Jerusalem in the 1940s and '50s, when the Finance minister called. After two weeks of lobbying by Netanyahu, Fischer accepted the job on January 9. The appointment made front-page news in Israel the next day, and Tel Aviv's TA-25 index gained 0.8 percent.

The arrival of such a prominent international figure carries a cultural significance that extends far beyond the central bank. The Jewish Agency for Israel, the government body that handles immigration, has enlisted Fischer in its efforts to reverse a decline in new arrivals to this country of 6.8 million people. Immigration fell 9 percent last year, to 22,134, a far cry from the pace of the 1990s, when more than 1 million immigrants arrived.

In May, Fischer was the main speaker at an event to kick off an agency project designed to bring Jewish youth to study in Israel. Speaking slightly hesitant Hebrew with an American accent, he told the audience at Beit Guvrin National Park in southern Israel that becoming bank governor "symbolized the end of one journey -- that of a Jew from a Zionist family who always strove to be connected to the state of Israel -- and the beginning of another, that of a proud Israeli who stands at the head of an important institution and tries to advance the economy and society."

When he moved to Israel with his wife, Rhoda, a former administrator at Tufts University, MIT and George Washington University, he left three sons and four grandchildren behind in the U.S. He also traded his generous Citigroup salary, which, though undisclosed, was reported by Israeli newspaper Ma'ariv at $1.2 million, for the governor's paycheck of IS32,648 a month, or $88,000 a year.

HOWEVER MODEST HIS CURRENT SALARY, FISCHER has come a long way. He was born in 1943 in Northern Rhodesia, a British colony that gained independence in 1964 and changed its name to Zambia. His father, Philip, the son of a traveling cheese salesman, worked as an apprentice pharmacist in Latvia before emigrating to Africa in 1926. Philip settled in Mazabuka, a small town in Northern Rhodesia, in the 1930s and married Ann Kopelowitz, a South African whose parents had emigrated from Lithuania. Philip and Ann established a general store and had two children -- Stanley, born in 1943, and a younger son, Denis, who died of cancer at an early age.

In Zion in Africa: Jews of Zambia, by Hugh Macmillan and Frank Shapiro, Fischer describes his modest upbringing. When he was born, his parents lived behind their store, in a house with no running water. They lit the house with hurricane lamps, powered the radio with batteries and played records on a wind-up gramophone. In 1956 the family moved to Bulawayo in Rhodesia, now Zimbabwe, where he joined the Zionist youth group Habonim.

Fischer developed a close affinity with Israel from an early age. In his interview with II, he recalls rummaging through a closet in the Mazabuka house and finding a newspaper his parents had kept that published Israel's declaration of independence. His father taught him the Hebrew alphabet at home before sending him to a Jewish boarding school in Cape Town in South Africa at the age of 11. In his inauguration speech in May, Fischer recalled that he stopped studying for several days in October and November 1956 to follow developments in the Suez War, when Israel, the U.K. and France attacked Egypt over its nationalization of the Suez Canal.

"We grew up in Rhodesia thinking it's likely we'll live in Israel, so as a kid of 15, that's what I thought," Fischer tells II. "The South African Jewish community is very closely tied to Israel."

Fischer left Africa to study at the London School of Economics, his interest sparked in part by admiration for Dag Hammarskjöld, the Swedish economist and diplomat who served as secretary general of the United Nations from 1953 until 1961, when he died in a plane crash in Zambia. Hammarskjöld's career made Fischer realize "that economics would help you do good," he recalled last year in an interview with Olivier Blanchard, the professor of economics at MIT with whom he cowrote Lectures on Macroeconomics.

In 1969, Fischer obtained a Ph.D. at MIT, where he worked under the guidance of professors Paul Samuelson and Robert Solow, both of whom later won the Nobel Prize for economics. Another mentor was visiting professor Dan Patinkin, the Chicago-born economist who moved to Israel in 1949 and founded Hebrew University's economics department.

Fischer spent three years as an assistant professor at the University of Chicago, where he befriended Frenkel, then a fellow assistant professor, and Rudiger Dornbusch, another rising young economist. In 1973, Fischer returned to MIT as an associate professor, gaining tenure four years later. In 1978 he and Dornbusch, then also established at MIT, co-authored Macroeconomics, a textbook that is still widely read by undergraduates.

Fischer was a favorite among the students, sometimes joining them to jog along the Charles River or grab a pizza, recalls Richard Startz, a former student who is now a professor at the University of Washington in Seattle. Several of Fischer's students went on to become distinguished economists, including Ben Bernanke, the new chairman of the White House Council of Economic Advisers; N. Gregory Mankiw, whom Bernanke succeeded; and Lawrence Summers, Harvard University's president and a former U.S. Treasury secretary.

"He had a very eclectic style," Bernanke recalls in an interview. In the 1970s there was a lot of tension in the field between Keynesians, who focused on aggregate demand as the key to growth and employment, and adherents of the emerging rational expectations school of thought, according to whom economic outcomes are deemed to depend largely upon what consumers and businesses expect to happen. "What Stan did, both in his own research and in his teaching, was to try to say, 'We want to take advantage of these new ideas and techniques, but we don't want to abandon what we already know,''' Bernanke says.

In the 1970s and '80s, Fischer spent three short stints as a visiting professor and research fellow at Hebrew University. His transformation from academic to policymaker began in earnest in 1988 when he was appointed chief economist at the World Bank. In that post, he visited countries like India for the first time and discussed market-oriented reforms with the late Zhao Ziyang, the Communist Party leader who was put under house arrest after Beijing cracked down on pro-democracy protesters in Tiananmen Square in 1989. He returned to MIT in 1990, replaced at the Bank by Summers.

Four years later, with Summers in charge of international affairs at the U.S. Treasury, Fischer was tapped for the No. 2 job at the IMF by the Fund's managing director, Michel Camdessus. Soon he was at the center of the action as the Fund, working hand-in-glove with the Rubin-Summers Treasury, handled a series of national financial crises in Argentina, Brazil, Mexico, Russia and Turkey, as well as the regional crisis in Asia. He was instrumental in crafting and implementing the Washington consensus, ordering countries in crisis to rein in their budget deficits, tighten monetary policy and liberalize trade in return for bailouts, just as he had recommended to Israel a decade earlier. "Stan was the intellectual reference in our team, due to his prestigious past in the academic world," Camdessus recalls in an interview.

The IMF's policy prescription, and Fischer's role in enforcing it, came in for heavy criticism from some countries and economists. Joseph Stiglitz, the Nobel Prize laureate and former chief economist at the World Bank, attacked the Fund for imposing austerity on countries where poverty and unemployment were rampant. The IMF prescribed "outmoded, inappropriate, if 'standard' solutions, without considering the effects they would have on the people in the countries told to follow these policies," he wrote in his book Globalization and Its Discontents. In a 2001 speech at the Institute of Policy Studies in Singapore, Fischer broadly defended the IMF's policies in Asia, but he acknowledged the validity of some criticisms and said the Fund had shifted its stance. He cited the IMF's new emphasis on flexible rather than fixed exchange rates and a shift toward more-gradual liberalization of capital rules.

Notwithstanding the criticism, Fischer's reputation in developing countries was so strong that in 2000, when the U.S. and the European Union clashed over the successor to Camdessus as IMF managing director, Angola, representing 20 Africa countries, nominated Fischer for the job. The post eventually went to Horst Köhler, then president of the European Bank for Reconstruction and Development and now president of Germany. Fischer left the IMF in 2001 and the following year became vice chairman at Citigroup, where he joined his old colleague Rubin and handled the bank's relations with governments.

At the Bank of Israel, Fischer got off to a good start in June when, barely a month into the job, he persuaded Netanyahu and Sharon to abolish the shekel's exchange rate band against a basket of currencies. The move had little practical impact -- the 60 percent band was so wide that the bank hadn't needed to defend the shekel since 1997 -- but it was a symbolic step designed to show investors that Israel's economy was liberal and open. Fischer's predecessor had tried and failed to abolish the band.

Fischer also appears to be having more success than his predecessors at modernizing the Bank of Israel's governing statutes. The law was last changed as part of the 1985 stabilization program, to prevent the central bank from financing the budget deficit. Klein and Frenkel tried to strengthen the bank's independence but failed because of the Ministry of Finance's opposition.

The central bank, the Finance Ministry and the prime minister's office are nearing agreement on a proposed amendment to the law that would effectively adopt an inflation-targeting policy framework similar to the Bank of England's, officials say. The amendment would set up two policymaking committees -- one to set interest rates and one to handle the bank's administrative needs. It also would define the bank's primary goal as maintaining price stability and allow it to support growth only if that goal isn't endangered. The government expects to vote on the amendment as early as this month and then put it to Parliament; the only risk to its passage is if early elections interrupt approval.

"The legal framework is a big thing," Fischer says. "We have a very antiquated structure and antiquated rules. You don't build institutions on the assumption that everybody in the system is going to be an angel. You need to build a system that guards your independence but at the same time doesn't allow you a free hand."

In drafting his proposal for reducing unemployment and poverty, Fischer is supporting ideas first suggested by his predecessor to offer tax credits to people with low incomes to make work more attractive than drawing welfare benefits. Finance Minister Olmert says he supports the proposal, which must first be approved by a government committee.

Poverty has become a growing issue in Israel despite the country's relative prosperity. Per capita GDP stands at $17,300, about 10 percent higher than Greece's and nearly 80 percent of the average of European members of the Organization for Economic Cooperation and Development. The proportion of families living below the poverty line, defined as half the median income, rose to 19.3 percent in 2003 from 18.1 percent a year earlier.

"We could certainly catch up to Western Europe," Fischer says. "We could even catch up to the U.S. if we manage things right. But we could overtake much more rapidly if we have peace."

Peace is beyond his pay grade, but Fischer is determined to contribute to increasing prosperity in Israel and the wider region. That's an ambitious mission, but one for which his career has prepared him.