One year ago, Yakir Plessner, professor of economics at Hebrew University (Rehovot) and former deputy governor of the Bank of Israel, reviewed the performance of Israeli monetary policy during 1985-1990 (Policy Studies No. 9, June 1991). In Policy Studies No. 12, Professor Plessner assesses the conduct of monetary policy in 1991, providing an objective, independent review of the activities and performance of the Bank of Israel.

Plessner notes a few positive achievements: all restrictions on borrowing from abroad were lifted; banks were permitted to invest a smaller fraction of savings deposits in government bonds; and, liquidity requirements on the banking system were further reduced.

These modest attainments were more than offset by a number of policy failures. First, the Bank tolerated an increase in government borrowing, thus crowding out, and thereby harming, private sector investment. Second, the Bank tolerated an unacceptably high interest rate spread between deposits and loans, to the detriment of the public. Third, the March 1991 devaluation was unnecessary for monetary purposes. Finally, the adoption of a "crawling peg" system of daily currency devaluation, which replaced the previous effort at sustaining a fixed exchange rate, injected serious instability into the monetary system.

Professor Plessner chides the Bank for its persistent failure to identify inflation as public economic enemy number one. Israelis appear complacent with 15 percent annual inflation, compared with historical episodes of hyperinflation in the 1980s, but this rate is nearly 10 percentage points higher than Israel's main trading partners, which the U.S. and Europe would regard as catastrophic. High inflation imposes a risk premium on both domestic and foreign investment. It retards the spread of emerging financial instruments. It creates fluctuations in interest rates on overdraft accounts. Plessner argues that only a fixed exchange rate can effectively fight inflation. And, unless inflation is once and for all curtailed, economic growth will remain a will-o'-the wisp.