Call Uncle Sam
by Alvin Rabushka, Director, Division for Economic Policy Research

In the late 1970s and early 1980s, Israel experienced accelerating inflation.  Inflation first reached triple digits (111.4%) in 1979, hit 190.7% in 1983, 444.9% in 1984, and was running at an annual rate of about 800% during the latter part of 1984.  Reflecting the run-up in prices, a 1,000 shekel note was put into circulation on November 17, 1983, followed by a 5,000 shekel note on August 9, 1984, and a 10,000 shekel note on November 27, 1984.  A 50,000 shekel note was prepared for circulation.

Secretary of State George P. Shultz was concerned that runaway inflation was threatening a financial meltdown of the Israeli economy.  He offered Minister of Finance Shimon Peres a special aid package of $1.5 billion as part of a plan to curtail Israeli inflation.  The additional aid would be used to finance Israel’s imports while Israel called a halt to the monetary printing presses.

U.S. aid to Israel had begun in earnest in 1973 at just under $1 billion.  It reached an annual level of about $1.5 billion in 1983.  The additional aid offered by Secretary Shultz increased the level to almost $4 billion in 1984.  Aid has since fluctuated around $4 billion.  Altogether, Israel has received over $100 billion in U.S. aid since 1973.

On September 4, 1985, the inflated shekel was replaced by the new Israel shekel (NIS).  Three zeros were dropped from the old shekel denominations.  Notes in the denominations of 1, 5, 10, 20, and 50 new shekels were issued between 1985 and 1988.  A 200 new shekel note was issued in 1991 and a 500 new shekel note is scheduled for release this year.

The new shekel was set at an initial rate of $1=NIS 1.5.  The current exchange rate is $1=NIS 4.14.  The inflation rate, which was 185.2% in 1985, fell sharply to 19.7% in 1986, and further to 16.1% in 1987.  It took until 2000 to reduce inflation to Western European levels.  Between 1986 and 2001, the new shekel depreciated from 67 cents to the dollar to 24 cents to the dollar, a decline of 64%.

Inflation has been a chronic problem in Turkey, currently running at an annual rate of 60%.  It recently devalued its currency, the lira, from about 750,000 to the dollar to more than 1 million to the dollar.  The country has received $17 billion in international aid from the International Monetary Fund and World Bank, of which $8 billion was approved in April by the Bush administration.

Turkey is a large country with a population numbering around 70 million.  Like Israel, its economy is heavily state-controlled and state-directed.  The bulk of the government’s budget goes to pay salaries of bureaucrats and most large companies are state monopolies.  Turkey would benefit from a heavy dose of free-market reforms.

Back to inflation.  Israel receives about $4 billion in U.S. aid every year.  It receives several billion dollars in other grants and transfers.  These large sums permit Israelis to live well beyond their means.  By financing the deficit in Israel’s international accounts, the large inflows permit the Bank of Israel to maintain a reasonable degree of control over the country’s money supply and a relatively stable exchange rate for the shekel.

Now it becomes clear what advice the three Israeli wise men can offer Turkey:  Get more aid.  In addition to aid from the IMF and World Bank, Turkey should ask the U.S. Congress for billions of dollars in aid every year.  If the Turks can get enough U.S. aid, then it’s possible they can reduce inflation to manageable levels and keep it under control.

Perhaps this is why Turkey’s new economy chief, Kermal Davis, accepted Shimon Peres’s offer of Israeli advice.  If he can get sufficient aid—he can attach letters of recommendation from distinguished Israeli economists in his request to the U.S. government—then he can stabilize Turkey’s currency without having to wage the political battles that would be necessary to reform its heavily state-controlled economy.

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