Monetary policy in the recovery process Prof Zvi

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Monetary policy in the recovery process Prof. Zvi Eckstein Deputy Governor, Bank of Israel Monetary policy in the recovery process Prof. Zvi Eckstein Deputy Governor, Bank of Israel YPO 2010 06. 2010 1

Outline • The Israeli Macro Economic • Monetary Policy • Israel Industry • Challenges Outline • The Israeli Macro Economic • Monetary Policy • Israel Industry • Challenges 2

Growth rates Israel, US and Europe % (Quarterly rates in annual terms) Lehman Brothers Growth rates Israel, US and Europe % (Quarterly rates in annual terms) Lehman Brothers collapse 4 3. 04 1. 79 2011 Forecasts Crisis begins Back to growth Bear Sterns rescue The growth is “V” shaped 3 Source: OECDStat *Temporary forecast by the B. O. I and I. M. F

Unemployment rates % 4 Source: OECD Stat *Annual forecast by B. O. I Israel, Unemployment rates % 4 Source: OECD Stat *Annual forecast by B. O. I Israel, US and Europe

World Financial Conditions: Libor and banks’ CDS spread Lehman Brothers collapse Bear-Sterns rescue Back World Financial Conditions: Libor and banks’ CDS spread Lehman Brothers collapse Bear-Sterns rescue Back to growth PIIGS Crisis begins CDS (right) 3 M Libor-OIS (left) 5 Source: BOI. CDS spread: average of world’s 9 largest banks

Fiscal Policy Public spending (right) 42. 8 • New Fiscal Rule (2011 (left) – Fiscal Policy Public spending (right) 42. 8 • New Fiscal Rule (2011 (left) – on): Debt 76. 8 Increase in expenditure = [60/(Debt/GDP)] * Ave 10 y growth Deficit (right) 6. 5 3. 8 2. 6 Or decreasing Deficits as % of GDP (3, 2, 1). For 2011/2012 budget = 2. 6% 6 Source: BOI , CBS

Monetary policy objectives in the new BOI law • Price stability (inflation target 1%-3%) Monetary policy objectives in the new BOI law • Price stability (inflation target 1%-3%) • Support of employment and growth Subject to price stability over time • Support of financial stability • These three objectives were evident during the crisis in the flexible inflation-targeting policies taken by the BOI and other central banks world wide 7

What is a flexible inflationtargeting policy? BOI interest rate is influenced by: • Past What is a flexible inflationtargeting policy? BOI interest rate is influenced by: • Past and expected inflation • Actual and expected output gap • Previous nominal interest rate Interest rate change following inflationary shocks and the output gap (actual and expected)—a policy to sustain price stability and moderate real business cycles 8

Interest rates of central banks EU, US, UK and Israel % Northern Rock UK Interest rates of central banks EU, US, UK and Israel % Northern Rock UK Israel US Crisis begins EU JAPAN 9 Lehman Brothers collapse

Annual inflation and expected inflation % 10 year market derived inflationary expectations Lehman Brothers Annual inflation and expected inflation % 10 year market derived inflationary expectations Lehman Brothers collapse 10 Source: BOI

Interest rate and year-on-year inflation fan charts Inflation 11 BOI interest rate Interest rate and year-on-year inflation fan charts Inflation 11 BOI interest rate

Back to growth: a slow process of returning to normality • April's interest rate Back to growth: a slow process of returning to normality • April's interest rate increases to 1. 5%: A sign of exiting the crisis and a rise in activity, expected inflation in upper part of target. • February and March rate unchanged. Why? • Actual and expected inflation in center of target range • Output gap still high • Growth begins to recover • European credit crisis • No expected interest rate increases from other central banks 12

Balance of payments (quarterly) $ millions Exports of Goods and services (left) Current account Balance of payments (quarterly) $ millions Exports of Goods and services (left) Current account (right) • Exports Vs. Imports balance: Surplus in Capital Account Imports of Goods • Result: A stable, strongservices (left) and Shekel 13 Source: BOI

NIS/Dollar exchange rate nominal-effective and real-effective exchange rates Index Nominal-effective (left) NIS/$ (right) Daily NIS/Dollar exchange rate nominal-effective and real-effective exchange rates Index Nominal-effective (left) NIS/$ (right) Daily $ 100 M purchase Daily $ 25 M purchase 14 Source: BOI Purchase according to market fluctuations NIS

BOI’s foreign exchange market policy: Long Run – FX market free of intervention excepting BOI’s foreign exchange market policy: Long Run – FX market free of intervention excepting anomalous events Short run – Slow process of returning to normality 15

Israel Industry • High Share of High Tech • High correlation with International Trade Israel Industry • High Share of High Tech • High correlation with International Trade • Low innovation in traditional industry • Problem: Strong Shekel 16

Exports by technology intensity $ millions 17 Source: BOI Exports by technology intensity $ millions 17 Source: BOI

Industrial production by technological intensity 18 Source: Makov report (2007), CBS (Israel 2008). EU Industrial production by technological intensity 18 Source: Makov report (2007), CBS (Israel 2008). EU average: Italy, Belgium, Denmark, Finland France.

Industry: GDP, productivity, capital per worker and R&D: Israel/USA GDP per worker Total Factor Industry: GDP, productivity, capital per worker and R&D: Israel/USA GDP per worker Total Factor Capital per productivity worker R&D Low and mediumlow technology 56% 44% 97% 42% Medium and medium-high technology 53% 52% 89% 42% High technology 89% 66% 102% 113% All industry 63% 59% 94% 98% 19 Source: Makov report on enhancing the periphery and low-technology industry (2007)

Challenges • Low participation and poverty • Education • Peace and economy 20 Challenges • Low participation and poverty • Education • Peace and economy 20

Thank you! 21 Thank you! 21




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