Monetary policy in the recovery process

1. Monetary policy in the recovery process Prof. Zvi Eckstein Deputy Governor, Bank of Israel YPO 2010 06.06.2010 1 1

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

3. Growth ratesIsrael, 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 3 Source: OECDStat*Temporary forecast by the B.O.I and I.M.F

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

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

6. Fiscal Policy Public spending (right) • New Fiscal Rule (2011 – on): Increase in expenditure = [60/(Debt/GDP)] * Ave 10y growth Or decreasing Deficits as % of GDP (3, 2, 1). For 2011/2012 budget = 2.6% 42.8 Debt (left) 76.8 Deficit (right) 6.5 3.8 2.6 Source: BOI, CBS

7. 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

8. What is a flexible inflation-targeting 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

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

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

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

12. 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

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

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

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

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

17. Exports by technology intensity $ millions Source: BOI

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

19. Industry:GDP, productivity, capital per worker and R&D:Israel/USA 19 Source: Makov report on enhancing the periphery and low-technology industry (2007)

20. Challenges • Low participation andpoverty • Education • Peace and economy

21. Thank you!