Challenges faced by Advanced Inflation Targeters: The Case of Israel Karnit Flug Bank of Israel Prepared for a Conference at the Czech National Bank, April 8 28
Economic Performance of the Israeli Economy
13 11 GDP and Business-Sector Product (1995-28*) 11.3 GDP Business-sector product 9 8.5 8.9 7 5 3 6.6 5.4 6.6 2.83. 4.9 4.2 2.92.8 2.3 3.2 7.2 6.5 6.5 6.1 5.2 5.3 5.2 5.3 3.6 3.2 1-1 -.4 -.6-3 -1.7-2.5-5 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28F * BOI Forecast. SOURCE: Central Bureau of Statistics.
% Budget Deficit* (percentage of GDP, 1995-27) 6 Deficit Target Actual Deficit 5.4 5 4 3 3.8 4.2 3.2 4. 3.2 3.1 3.1 3.2 2.9 2.8 3.6 4.4 3.9 3.8 3. 4. 3.6 3.4 3. 2.9 2 1.8 1.9 1.6 1.7.9 1995 1996 1997 1998 1999 2 21 22 23 24 25* 26 27 28. *Percent of GDP; excluding credit extended. Until 1996, domestic deficit; from 1997, total deficit. *The data from 2 refer to the deficit excluding the Bank of Israel s profits.
% 12 Public Sector Debt, Percentage of GDP, 1995-27 (year-end) 1 8 14.5 12.6 11.8 13.3 97.5 87.1 91.9 99.8 11.7 99.9 95.7 86.6 8.6 6 4 2 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27
% 12 Rate of Unemployment 1995-27 (Annual) 1.3 1.7 1.4 9 8.6 9. 8.8 9.3 9. 8.4 6.8 6.6 7.6 7.3 6 3 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 SOURCE: Based on Central Bureau of Statistics Labour Force Survey.
Current Account of Balance of Payments as Percentage of GDP, 1995-27 (Annual) 8 6 6. 4 2.4 3.3 3.1 2 1.2-2 -.9-1.4 -.8-1.1 -.8-4 -3.1-6 -5.1-5. 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 SOURCE: Balance of Payments, Central Bureau of Statistics.
% 17 15 14 12 11 9 8 6 5 3 2 % 2 18 16 14 12 1 8 6 4 2 Direct investment 5,58 5,62 Investment in Israel by Nonresidents (as percentage of GDP, 2-27) 2 21 22 23 24 25 26 27 2,149 3,336 75 3,626 Investment of Israeli Residents Abroad Direct investment 1,623 688 723 1,767 Portfolio investment 1,812 3,822 (as percentage of GDP, 2-27) 2,78 982 Portfolio investment 3,154 2,65 2 21 22 23 24 25 26 27 7,251 2,12 2,381 4,548 4,217 4,868 8,244 2,941 8,798 14,694 9,79 14,992 27 1,276 6,649 7,64 SOURCE: Central Bureau of Statistics, Balance of Payments.
Monetary Policy Regime
NIS 8 7 6 5 4 3 2 1 NIS/Currency-Basket Exchange Rate 8/86 8/87 8/88 8/89 8/9 8/91 8/92 8/93 8/94 8/95 8/96 8/97 8/98 8/99 8/ 8/1 8/2 8/3 8/4 8/5 8/6 8/7 Adoption of IT Declaration of IT Full-fledge IT
Inflation and Inflation Targets 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 Inflation Targets 14-15 1 8 8-11 8-1 7-1 7-1 4 3-4 2.5-3.5 2-3 1-3 1-3 1-3 1-3 1-3
Israel Norway New Zealand Spain Finland Korea Canada Sweden Thailand Columbia Czech Republic Chille Peru Philippines Poland Mexico Hungary South Africa Brazil 7 6 5 4 3 2 1 Australia Iceland United Kingdom Inflation Targets in the World Target Center Developed Countries Developing Countries Annual Inflation Target
Monetary Policy
% 17 15 Rate of Inflation in Last 12 Months, Inflation Expectations* and Inflation Targets, 1994 1994-28 Inflation during previous 12 months Inflation target 13 11 9 Inflation Expectations 7 5 3 1-1 -3 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 *For 12 months, as derived from the capital market.
% Bank of Israel Interest Rate, and Actual Inflation*, 1994-28 2 Bank of Israel interest rate 15 1 5 Actual Inflation -5 1/94 6/94 11/94 4/95 9/95 2/96 7/96 12/96 5/97 1/97 3/98 8/98 1/99 6/99 11/99 4/ 9/ 2/1 7/1 12/1 5/2 1/2 3/3 8/3 1/4 6/4 11/4 4/5 9/5 2/6 7/6 12/6 5/7 1/7 3/8 *In last 12 months.
% 18 Bank of Israel Interest Rate, Inflation Expectations*, and the Fed s s interest Rate, 1994-28 16 14 Bank of Israel interest rate 12 1 8 6 Fed's interest rate 4 2 1/94 6/94 11/94 4/95 9/95 2/96 7/96 12/96 5/97 1/97 3/98 8/98 1/99 6/99 11/99 4/ 9/ 2/1 7/1 12/1 5/2 1/2 3/3 8/3 1/4 6/4 11/4 4/5 9/5 2/6 7/6 12/6 5/7 1/7 3/8 *For 12 months, as derived from the capital market.
Challenges
Rate of Inflation in Last 12 Months, Inflation Targets and Deviations from Inflation Targets, 23-28 28 % 7 Deviations from above Deviations from below 6 5 4 3 2 1-1 -2-3 -4-5 Rate of Inflation in Last 12 Months Inflation Targets 23 24 25 26 27 28
Price Index and Shekel/Dollar Exchange Rate Percent 12 1 8 6 4 2 (Rate of change over 12 months, up to February 28 ) 19 Price index Exchange rate 14 9 4-1 -6-2 -11 1/97 7/97 1/98 7/98 1/99 7/99 1/ 7/ 1/1 7/1 1/2 7/2 1/3 7/3 1/4 7/4 1/5 7/5 1/6 7/6 1/7 7/7-4 -16 1/8
Pass-Through from Exchange Rate to Prices: International Evidence and the Israeli Experience Developed Economies Emerging Markets Israel Over 1 Quarter.5.15.3 Over 1 Year.1.2.5 In the second half of 27 the Pass-Through has dropped sharply. Source: Choudhri and Hakura (23) and bank of Israel estimetes
Volatility of the Exchange Rate in Israel and in Developed and Developing Countries 1997-27 5 4.5 4 3.5 3 2.5 2 1.5 1.5 Singapore Canada Israel Mexico United Kingdom Chile United States Norway Sweden Poland Iceland Czech Republic South Africa Korea Developed Countries Developing Countries a SD of monthly depreciation against the US$. For US - US$ against synthetic.
.7.6.5.4.3.2.1 Volatility of Inflation in Israel and in Developed and Developing Countries 1997-27 Canada UK Chille Sweden Singapur Norway South Africa Korea Mexico Israel Poland Iceland Czech Republic USA Developed Countries Developing Countries
$ Commodities and Oil Prices (6/21=1,6 /21-3/28) 4 35 3 25 2 15 1 5 Dec-7 Jun-1 Dec-1 Jun-2 Dec-2 Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Jun-6 Dec-6 Jun-7 Non Energy Commodities Commodities Oil Prices
Index of Real Exchange Rate by Trading Partners (1 /1997-3/27) % 135 13 125 12 115 115.6 11 15 1 95 9 1/97 7/97 1/98 7/98 1/99 7/99 1/ 7/ 1/1 7/1 1/2 7/2 1/3 7/3 1/4 7/4 1/5 7/5 1/6 7/6 1/7 7/7 1/8 A rise in the index indicates depreciation. The figure for March 28 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 November 27 to March 28, Bank of Israel calculations.
Most Recent Developments: A two day intervention (during 13-14/3/8) in FX market where the Bank of Israel purchased FX due to disorderly sharp appreciation of the NIS. An announcement of the intention to purchase FX at an amount of some 25 million US$ per day over the next 2 years aimed at raising FX reserves to a more adequate level of 35-4 billion US$. Two consequtive reductions of interest rates for March and April by.5% each
March 13-14, 28-2.62% Shekel/Dollar -2.52% Shekel/Euro
The Change in Foreign Exchange Reserves ($,1998-27) 45% 4% 35% 3% 25% 2% 15% 1% 5% % -5% -1% 1998 1999 2 21 22 23 24 25 26 27 World Reserves OECD Non OECD Israel Eurozone OECD ex Eurozone Source: IMF
Final Comment During the Inflation Targeting Regime we had high volatility of inflation and frequent episodes where inflation was outside the target range. However, expectations for inflation were always, in recent years, within the inflation target range. Thus, by anchoring expectations within the price stability range, inflation targeting has provided a stable environment to economic agents.
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