Last week, Israel’s central bank took a step away from the neoliberal policies that have governed the Israeli economy for four decades. The Bank of Israel announced on Thursday that it will subsidize banks that offer cheap loans to small businesses. Small businesses are struggling to access credit during the coronavirus crisis

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The BOI’s announcement marks a rare act of direct intervention in financial markets. The bank will offer funds at the negative rate of -0.1% to banks, on the basis of cheap credit offered to small businesses at the rate of prime, plus 1.3%.

Small- and medium-sized businesses in Israel have struggled to obtain credit during the coronavirus crisis.Banks are hesitant to lend to more vulnerable companies during a pandemic. Without access to loans, small businesses are struggling, making their hopes of securing credit in the future even dimmer. 

Channeling credit to the most stressed parts of the economy may seem like a reasonable policy decision during a crisis, but for the BOI it signals a considerable paradigm shift. Just a few months ago, no one in Israel would have dared imagine the central bank exerting such direct control over the economy.

Beyond the banker’s jargon, the significance of the BOI’s new policy challenges one of the most basic principles of neoliberal economics: that the central bank must use only interest rates, not direct intervention, to regulate the economy.

The BOI’s announcement mirrors programs in other countries. The Bank of England has been running a similar program since 2014. The European Central Bank offers long-term loans to European banks, which are interest-free as long as the banks lend the money to real companies. The ECB made it even easier for small businesses to get those loans at the outset of the coronavirus pandemic.

Going beyond interest rates

According to conservative economics, things aren’t supposed to work this way. Since the 1980s, neoliberal economists have insisted that central banks’ only job is to regulate the money supply to keep inflation low. Central banks were supposed to raise or lower the interest rates to either incentivize or deter banks from lending money.

Neoliberal economists see direct management of the financial markets as a thing of the past, a relic of the Keynesian era. According to neoliberal theory, banks must be free to make decisions based solely on profitability. When governments regulate markets directly, neoliberal economists say they are distorting prices and interfering with the smooth functioning of the market.

Neoliberal policies began to change slightly following the 2008 financial crisis. The Federal Reserve System in the United States, the Bank of England, and the European Central Bank found they could not rely solely on interest rate cuts, so they began using what were euphemistically known as “unconventional tools.” One of those tools was the kind of program that the BOI is now trying: paying banks to ensure that cheap credit reaches those parts of the economy that need it most. Since Israel avoided the worst impacts of the 2008 crisis, the conservative mindset has persisted – until now.

The BOI is offering cheap credit, but the loans will still have to be repaid. Some small businesses may be reluctant to increase their debt load in a time of such deep uncertainty. Still, the new policy may mark a paradigm shift. Increased market intervention may lay the groundwork for what the Israeli economy really needs: more far-reaching  fiscal stimulus.