monetary policy issues in israel
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1
Monetary Policy Issues in
Israel
Stanley FischerBank of Israel
Prepared for Presentation at the Research Conference
of the Central Bank of Chile, November 15-16 2007
2
Economic Performance
3
Growth Rate of GDPGrowth Rate of GDP2000-20072000-2007%
8.9
-0.4 -0.6
2.3
5.2 5.3 5.2 5.4
-2
0
2
4
6
8
10
2000
2001
2002
2003
2004
2005
2006
2007
BI- Forecast
4
%
3.6
1.8
3.9 4.03.8
3.4
3.02.9
1.6
0.7
4.4
3.8
5.4
3.7
1.9
0.9 0.8
0
1
2
3
4
5
6
2000 2001 2002 2003 2004 2005* 2006 2007 2008
Deficit Target Actual Deficit
Budget Deficit** (percentage of GDP, 2000-2007)
*Percent of GDP; excluding credit extended. Until 1996, domestic deficit; from 1997, total deficit. *The data from 2000 refer to the deficit excluding the Bank of Israel’s profits.
Under the assumption
that the budget is fully
performed
5
Public Sector Debt,Percentage of GDP, 2000-2007 (year-end)
87.091.9
99.8 101.7 99.995.9
86.781.5
0
20
40
60
80
100
120
2000 2001 2002 2003 2004 2005 2006 2007E
%
6
Rate of Inflation in Last 12 Months Rate of Inflation in Last 12 Months and Inflation Targets, and Inflation Targets, 1992-20071992-2007
-3
-1
1
3
5
7
9
11
13
15
17
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Inflation during previous 12 months
Inflation target
%
7
Bank of Israel Interest Rate, Inflation Bank of Israel Interest Rate, Inflation Expectations*, and the Fed’s interest Rate, Expectations*, and the Fed’s interest Rate,
2004-20072004-2007
0
1
2
3
4
5
6
01/0
402
/04
03/0
404
/04
05/0
406
/04
07/0
408
/04
09/0
410
/04
11/0
412
/04
01/0
502
/05
03/0
504
/05
05/0
506
/05
07/0
508
/05
09/0
510
/05
11/0
512
/05
01/0
602
/06
03/0
604
/06
05/0
606
/06
07/0
608
/06
09/0
610
/06
11/0
612
/06
01/0
702
/07
03/0
704
/07
05/0
706
/07
07/0
708
/07
09/0
710
/07
11/0
7
Bank of Israel interest rate
Inflation expectations
Fed's interest rate
%
*For 12 months, as derived from the capital market.
8
The Nominal and the Real Exchange RateThe Nominal and the Real Exchange Rate2007 -2007 - 19971997
3.0
3.2
3.4
3.6
3.8
4.0
4.2
4.4
4.6
4.8
5.0
Nominal Exchange Rate
Exchange rate adjusted to inflation differential betweem Israel and U.S.
Shekel / Dollar Exchange Rate
90
95
100
105
110
115
120
125
130
135
The Real Exchange Rate by Trading Partners
)100=01/1997 ,01/1997-11/2007(127.6
NIS
*The Nis/$ chart is on a daily basis, while the real exchange rate chart is on a monthly basis.
•A rise in the index indicates depreciation.
•The figure for November 2007 is calculated from spot exchange rates known for the half-month, our forecast CPI from the monthly model, and an extrapolation of inflation in the countries whose currencies are in the currency basket.
•SOURCE: IFS data. For April to November 2007, Bank of Israel calculations.
9
Openness of the Israeli EconomyOpenness of the Israeli Economy(percentage of GDP, 1995-2007*)(percentage of GDP, 1995-2007*)
30
32
34
36
38
40
42
44
46
48
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007.I
Imports
Exports
%
*First half of 2007.
*Goods and Services.
Source: National accounts, CBS.
10
-5.1 -5.0
-3.1
-0.9-1.4
-0.8 -1.1 -0.8
1.2
2.4
3.3
4.85.6
-6
-4
-2
0
2
4
6
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
.I
Current Account of Balance of PaymentsCurrent Account of Balance of Paymentsas Percentage of GDP, 1995-2007* (Annual)
* First half of 2007.
* Foreign Currency Department forecast
•SOURCE: Balance of Payments, Central Bureau of Statistics.
11
Non-Monetary Policy Issues
12
Non Monetary Policy Issues:
• Bank supervision• Labor dispute• Reorganization• New law• Economic advisor to the government
13
Monetary Policy Issues
14
Volatility of Inflation and the Exchange Volatility of Inflation and the Exchange
Rate,Rate, 1997.1-2007.71997.1-2007.7
IsraelBrazilChileMexicoUKUSA
Inflationa2.68%3.60%1.13%2.25%0.72%0.90%
Exchange Rateb
1.76%3.76%2.30%1.66%2.01%2.33%c
a SD of 12 months inflation.
b SD of monthly depreciation against the US$.
C US$ against synthetic €.
15
Responses to FX and to Monetary Shocks
16
Impulse Response to an FX Shock Quarterly model of BoI Monetary Department
BoI Interest rate
0.0
0.1
0.2
0.3
0.4
1 2 3 4 5 6 7 8 9 10
Annualized Quarterly Inflation
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1 2 3 4 5 6 7 8 9 10
Output gap
-0.06
0
0.06
0.12
0.18
1 2 3 4 5 6 7 8 9 10
FX rate (percentage deviation from level)
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1 2 3 4 5 6 7 8 9 10
t
tx te
ti
* Shock of 1 percentage point.* Immediate pass-through to inflation is about one third (FX-level, Inflation-annualized!).* Complete (though gradual) pass-through.
SOURCE: Bank of Israel – Monetary department.
17 * Shock of 1 percentage point.
SOURCE: Bank of Israel – Monetary department.
Impulse Response to an Interest Rate Shock Quarterly model of BoI Monetary Department
BoI Interest rate
0
0.2
0.4
0.6
0.8
1
1.2
1 2 3 4 5 6 7 8 9 10
Annualized Quarterly Inflation
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0
0.1
1 2 3 4 5 6 7 8 9 10
Output gap
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
1 2 3 4 5 6 7 8 9 10
FX rate (percentage deviation from level)
-0.45
-0.40
-0.35
-0.30
-0.25
-0.20
1 2 3 4 5 6 7 8 9 10
t
tx
ti
te
18 SOURCE: Bank of Israel – Monetary and Research departments.
Impulse Response to an FX ShockVAR(2)
BoI Interest rate
0.00
0.08
0.16
0.24
0.32
1 2 3 4 5 6 7 8 9 10
Annualized Quarterly Inflation
-0.4
0.0
0.4
0.8
1.2
1 2 3 4 5 6 7 8 9 10
Output gap
-0.20
-0.15
-0.10
-0.05
0.00
1 2 3 4 5 6 7 8 9 10
FX rate (percentage deviation from level)
0
0.4
0.8
1.2
1 2 3 4 5 6 7 8 9 10
t
tx
ti
te
19
Impulse Response to an Interest Rate Shock (VAR(2))
BoI Interest rate
0
0.2
0.4
0.6
0.8
1
1 2 3 4 5 6 7 8 9 10
Annualized Quarterly Inflation
-1.5
-1.0
-0.5
0.0
0.5
1 2 3 4 5 6 7 8 9 10
Output gap
-0.3
-0.2
-0.1
0.0
0.1
1 2 3 4 5 6 7 8 9 10
FX rate (percentage deviation from level)
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
1 2 3 4 5 6 7 8 9 10
t
tx
ti
SOURCE: Bank of Israel – Monetary and Research departments.
te
20
Dealing with Inflation Volatility:
• Core inflation or local price inflation• Remove only housing from headline Inflation• Change the law • Let nature and good performance do their work
21
The Exchange Rate:
• Frequent pressures for intervention• Stronger shekel or weaker dollar – setting out
the facts• Fiscal policy • Does the interest rate react to the exchange
rate?
22
Asset Prices:
• Not our issue so far• Responsibility for financial stability• What to do in the case of irrational exuberance?
23
Interest Rate Smoothing:
• Why?
Publishing:• Inflation forecasts• Interest Rate forecasts• Biases, hints about future decisions
24
Interest Rate Policy:The Taylor Rule
25
The Estimated Equation
TARttetx
TARttt
TARt
BoIt
TARt
BoIt
eQxQ
EQii
111
1111111112 1
Variables:
t
t
t
e
x
TARt
BoIti
BoI interest rate.
Inflation target(Average of next 12 months).
Output gap.
Nominal FX w.r.t. the US$.
CPI Inflation.
tE Expectations.
Operators:
Difference.
26
Estimated Policy Rule of BoI1999.01-2007.09 ; monthly frequency
Coeff. (t-stat)
Intercept 0.38 (2.9)
Persistence 0.92 (36.1)
Inflation expectation Q 4.8 (2.9)
Output gap xQ 0.1 (3.0)
Nominal depreciation eQ 0.0 (0.3)
Adjusted R2 0.99
Durbin-Watson 1.90
* Estimation accounts for AR(1) process of the residuals.
27
The Estimated EquationIlek Alex (2006)
111111121
11
1
txTARttt
TARt
nt
BoIt
BoIt
BoIt
xQEQr
iii
Variables:
t
t
t
e
x
TARt
nt
BoIt
r
i
BoI interest rate.
Inflation target(Average of next 12 months).
Output gap.
Nominal FX w.r.t. the US$.
CPI Inflation.
tE Expectations.
Operators:
Difference.“Natural” real rate of interest.
28
Estimated Policy Rule of BoI1997.10-2006.04 ; monthly frequency ; Ilek (2006)
Coeff. (t-stat)
Lagged difference 0.34 (4.3)
Persistence 0.92 (46.0)
Inflation expectation Q 2.7 (3.6)
Output gap xQ 0.5 (1.7)
Adjusted R2 0.99
Durbin-Watson 1.60
29
Thank you
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