The Bank of Israel - Vol. 1

By Haim Barkai; Nissan Liviatan | Go to book overview

8
Early Attempts at Stabilization

The acceleration of inflation in the 1970s eroded some components of the financial repression (FR) regime. One reason for having applied FR to begin with, as noted, was the intention of increasing the demand for money and, consequently, broadening the base of the inflation tax. However, the rise of inflation, the prime motive for the introduction of money substitutes, depressed demand for money and, by so doing, made the inflation tax harder to “collect.” Concurrently, the very slow adjustment of nominal interest rates on the private sector’s debt to the government (which was unindexed until 1979) increased the implicit inflation subsidy that the Finance Ministry provided. Indeed, this subsidy rose to a daunting 6% of GNP in the late 1970s, exceeding the seigniorage component by far. In this sense, the “net inflation tax” had already become negative by the mid-1970s (figure 8.1). Thus, both the FR system and inflation became fiscally burdensome, not beneficial. Although this increased the incentive to stabilize the economy once and for all, political conditions in the late 1970s and early 1980s were still not ripe for such a drastic change in course.


THE TENURE OF YIGAEL HURWITZ AT FINANCE

In 1979, amid accelerating inflation, a deteriorating current account, and rising real wages, the government backtracked from its liberalization program. Various factors contributed to the acceleration of inflation that year. The first was the lagged effect of the monetary expansion in the previous year, precipitated by the money injection that the aforementioned rising fiscal deficit and capital inflow had set in motion. Second, the second oil shock (1978–79) caused import prices,

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