Monetary Policy and Inflation in Israel

03/03/1998 |  Bufman Gill, Leiderman Leonardo


​Monetary policy is the subject of sharp debate in Israel. Establishing a set of basic empirical regularities on these issues is a clear  prerequisite for resolving these controversies. The purpose of this paper is to provide a body of empirical evidence on the role of monetary policy measures in the inflation process.

Based on a sample of quarterly data from 1989 to 1997 we find that there is a close association between movements in the rate of inflation and shifts in monetary policy variables. The empirical results show that the impact of monetary policy variables - such as the rate of change of M1 beyond the rate of growth of GDP and the ex-ante real interest rate on Bank of Israel funds-on the rate of inflation works with lags that peak at about two quarters after the change in the monetary variable. Moreover, a relatively simple inflation equation does a relatively satisfactory job at predicting - in a one-step-ahead sense -- most recent quarterly movements in the rate of inflation.

The empirical methodology was applied in order to account for the reduction in the rate of inflation from about 16-18 percent in the period before 1991-92 to about 10 percent per year thereafter. The paper quantifies various developments in key variables, such as fiscal, monetary, labor market, and external that combined to produce a decline in the rate of inflation.


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