Remarks by Andrew Abir, Director of the Bank of Israel’s Market Operations Department: “Monetary Policy in the Era of Low Inflation”
Is monetary policy succeeding in meeting its targets? The labor market is at full employment, and the economy is growing in line with its potential growth rate. The main transmission mechanism from monetary policy to real activity has, in the past several years, operated mainly through the policy’s effect on private consumption, which has led economic growth. However, the inflation environment remains below the target. Some of the decline in inflation reflects the “import” of low inflation from abroad which, together with the effect of the shekel’s appreciation, leads to a decline in the prices of tradable goods. In Israel, inflation was also impacted by price reductions initiated by the government, while structural changes that are increasing competition in the market are acting to reduce inflation. These are desirable changes that are affecting price levels, and monetary policy is not trying to act against them or to offset them. However, a prolonged decline of the inflation rate to below the target may have negative ramifications for economic activity over time, and the Bank of Israel’s monetary policy is therefore expected to remain accommodative as long as necessary in order to entrench the inflation environment within the target range.
Abir discussed the gaps in consumer price levels between Israel and other OECD countries, and noted that there is a high correlation between the level of the real exchange rate and the price gap. Currently, the shekel is appreciated, so price levels in Israel are higher than abroad, since the appreciation lowers prices abroad in shekel terms more than prices in the domestic economy, where it only affects the prices of tradable goods. A real depreciation may narrow the price gap, as it was, for instance, in the middle of the previous decade.