111

Monetary policy in Monetary policy in the recovery processthe recovery process

Prof. Zvi EcksteinProf. Zvi Eckstein

Deputy Governor, Bank of IsraelDeputy Governor, Bank of Israel

YPO 2010YPO 201006.06.201006.06.2010

2

OutlineOutline

• The Israeli Macro Economic

• Monetary Policy

• Israel Industry

• Challenges

3

-12

-10

-8

-6

-4

-2

0

2

4

6

8

EU

USA

Israel

33

%

Source: OECDStat*Temporary forecast by the B.O.I and I.M.F

Bear Sterns rescue

Lehman Brothers collapse

Crisis begins

Back to growth

Forecasts

The growth is “V” shapedThe growth is “V” shaped

44

20112011

3.043.04

1.791.79

Growth ratesGrowth ratesIsrael, US and EuropeIsrael, US and Europe

(Quarterly rates in annual terms)(Quarterly rates in annual terms)

4

4

5

6

7

8

9

10

11

EU

Israel

US

44

Unemployment ratesUnemployment ratesIsrael, US and EuropeIsrael, US and Europe%

Source: OECD Stat*Annual forecast by B.O.I

5

0

0.5

1

1.5

2

2.5

3

3.5

4

07/2

007

10/2

007

01/2

008

04/2

008

07/2

008

10/2

008

01/2

009

04/2

009

07/2

009

10/2

009

01/2

010

0

50

100

150

200

250

300

350

World Financial Conditions: Libor and World Financial Conditions: Libor and banks’ CDS spreadbanks’ CDS spread

CDS (right)

3M Libor-OIS (left)

Source: BOI.CDS spread: average of world’s 9 largest banks

Bear-Sterns rescue

Lehman Brothers collapse

Back to growth

Crisis begins

PIIGS Crisis

6

80.379.8

44.4 41.8

-50

0

50

100

150

200

250

-15

0

15

30

45

60

GDP %GDP %

Fiscal PolicyFiscal Policy

Public spending (right)

Deficit (right)

Debt (left)

6.5 3.82.6

76.8

42.8

• New Fiscal Rule (2011 – on):New Fiscal Rule (2011 – on):

Increase in expenditure = Increase in expenditure =

[60/(Debt/GDP)] * Ave 10y growth[60/(Debt/GDP)] * Ave 10y growth

Or decreasing Deficits as % of GDP (3, 2, 1).Or decreasing Deficits as % of GDP (3, 2, 1).

For 2011/2012 budget = 2.6% For 2011/2012 budget = 2.6%

Source: BOI , CBS

7

• 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

Monetary policy Monetary policy objectives in the new BOI lawobjectives in the new BOI law

8

Interest rate change following inflationary shocks and the output gap

(actual and expected)—a policy to sustain price stability and moderate

real business cycles

BOI interest rate is influenced by:•Past and expected inflation

•Actual and expected output gap• Previous nominal interest rate

What is a flexible inflation-What is a flexible inflation-targeting policytargeting policy??

9

0

1

2

3

4

5

6

7

Interest rates of central banksInterest rates of central banksEU, US, UK and IsraelEU, US, UK and Israel

%

Northern Rock

Crisis begins

Lehman Brothers collapse

UK

Israel

EU

US

JAPAN

10

%

Lehman Brothers collapse

Annual inflation and expected Annual inflation and expected inflationinflation

10 year market derived inflationary expectations

Source: BOI

1111

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2008

:3

2008

:4

2009

:1

2009

:2

2009

:3

2009

:4

2010

:1

2010

:2

2010

:3

2010

:4

2011

:1

2011

:2

2011

:3

%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2008

:4

2009

:1

2009

:2

2009

:3

2009

:4

2010

:1

2010

:2

2010

:3

2010

:4

2011

:1

2011

:2

2011

:3

%

Interest rate and year-on-year Interest rate and year-on-year inflation fan chartsinflation fan charts

InflationInflation BOI interest rateBOI interest rate

12

Back to growth: a slow process Back to growth: a slow process of returning to normalityof 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

131313

9000

11000

13000

15000

17000

19000

21000

23000

-2500

-500

1500

3500

5500

7500

9500

Balance of payments Balance of payments (quarterly)(quarterly)

$ millions$ millions

Exports of Goods and services (left)

Imports of Goods and services (left)

Current account (right)

Source: BOI

• Exports Vs. Imports balance: Surplus in Exports Vs. Imports balance: Surplus in Capital AccountCapital Account

• Result: A stable, strong ShekelResult: A stable, strong Shekel

14

80

85

90

95

100

105

110

02/0

1/20

07

14/0

3/20

07

01/0

6/20

07

13/0

8/20

07

30/1

0/20

07

10/0

1/20

08

20/0

3/20

08

03/0

6/20

08

13/0

8/20

08

31/1

0/20

08

14/0

1/20

09

30/0

3/20

09

18/0

6/20

09

28/0

8/20

09

13/1

0/20

09

22/1

2/20

09

3

3.2

3.4

3.6

3.8

4

4.2

4.4

NIS/Dollar exchange rateNIS/Dollar exchange rate nominal-effective and real-effective exchange ratesnominal-effective and real-effective exchange rates

NIS/$ (right)Nominal-effective (left)

Index NIS

Source: BOI

Daily $ 25M purchase

Daily $ 100M purchase

Purchase according to

market fluctuations

15

Long Run – FX market free of intervention excepting anomalous events

BOI’s foreign exchange market policyBOI’s foreign exchange market policy::

Short run – Slow process of returning to normality

16

Israel IndustryIsrael Industry

• High Share of High Tech

• High correlation with International Trade

• Low innovation in traditional industry

• Problem: Strong Shekel

17

0

200

400

600

800

1000

1200

1400

1600

1800

High Technology Industries

Low Technology Industries

Medium-Low Technology Industries

Medium-High Technology Industries

Exports by technology Exports by technology intensityintensity

0

200

400

600

800

1000

1200

1400

1600

1800

High Technology Industries

Low Technology Industries

Medium-Low Technology Industries

Medium-High Technology Industries

$ millions

Source: BOI

18

Industrial production by Industrial production by technological intensitytechnological intensity

Source: Makov report (2007), CBS (Israel 2008). EU average: Italy, Belgium, Denmark, Finland and France.

21 25 30 30

2425

33 30

24

36

31 31

31

156 10

0

20

40

60

80

100

120

Israel USA Canada EU average

Low-Tech Medium-Low Tech

Medium-High Tech High-Tech

1919

Industry:Industry:GDP, productivity, capital per worker and GDP, productivity, capital per worker and

R&D:R&D:Israel/USAIsrael/USA

GDP per worker

Total Factor productivity

Capital per worker

R&D

Low and medium-low technology56%44%97%42%

Medium and medium-high technology

53%52%89%42%

High technology89%66%102%113%

All industry63%59%94%98%

Source: Makov report on enhancing the periphery and low-technology industry (2007)

20

ChallengesChallenges

• Low participation and poverty

• Education

• Peace and economy

21

Thank youThank you!!