Monetary Policy and Financial Stability Policies in Israel

Presented at Economic Presented at Economic Dialogue MeetingDialogue Meeting

byby

Dr. Edward OffenbacherDr. Edward OffenbacherDirector, Monetary/Finance Director, Monetary/Finance

Division, Research DeptDivision, Research Dept..Bank Of IsraelBank Of Israel

January 2012January 2012

Outline of Presentation

Key Macroeconomic DevelopmentsKey Macroeconomic Developments

Issues for Monetary PolicyIssues for Monetary Policy

Issues for Financial StabilityIssues for Financial Stability

Key Macroeconomic Developments

Slowdown of real growth after seven “good years” of export-led growth

Low unemployment but moderate wage increase..

BoP – CA deficit due mainly to ToT “hit”.

Inflation moderating after target misses..

House price inflation..

Fiscal policy: Expenditures within target path despite pressures from defense, social justice; tax receipts slowing due to growth slowdown so deficit missing target..

Monetary policy: Tension between domestic vs. foreign pressures.

Issues for Monetary Policy

Growth slowdown w/ economy near full Growth slowdown w/ economy near full employment: weak demand side or supply employment: weak demand side or supply constraints? Where is relevant potential output?constraints? Where is relevant potential output?

Slowing inflation: one-time effects or indicator of Slowing inflation: one-time effects or indicator of recession ahead? Why is wage growth subdued?recession ahead? Why is wage growth subdued?

Interest rate differentials: Potential for capital Interest rate differentials: Potential for capital inflow, local currency appreciation (on hold inflow, local currency appreciation (on hold recently).recently).

Complaints of Complaints of ““credit crunchcredit crunch”” –– how legitimate? how legitimate?

Financial Stability Policy Issues (1)

Financial stability policy (aka Macroprudential Financial stability policy (aka Macroprudential Policy): Do we know what it is? Do we have relevant Policy): Do we know what it is? Do we have relevant information and analysis information and analysis –– in the profession, in in the profession, in Israel? Contagion/network effects; Israel? Contagion/network effects; credibility/confidence.credibility/confidence.

Key measues taken in Israel: (a) Capital surcharge Key measues taken in Israel: (a) Capital surcharge on high LTV mortgages; (b) Limits on variable rate on high LTV mortgages; (b) Limits on variable rate mortgages; (c) Reporting/reserve requirements on mortgages; (c) Reporting/reserve requirements on foreign activity in Makam and derivatives; (d) foreign activity in Makam and derivatives; (d) Elimination of tax exemption for foreigners on Elimination of tax exemption for foreigners on Makam interest. Makam interest.

Key new measure: adoption of Basel III Tier 1 capital Key new measure: adoption of Basel III Tier 1 capital adequacy requirements for banks. adequacy requirements for banks.

Financial Stability Issues (2)

“Imported” issues European crisis – direct (financial) and indirect

(trade) exposures Geopolitical: Arab spring, Iran U.S.: Looking better for now, but…

“Home-made” issues Highly leveraged conglomerates House price inflation Construction industry loans

Thanks

8

GDP Growth Rates in Israel andGDP Growth Rates in Israel and in the Advanced Economies in the Advanced Economies

(2000-2011)(2000-2011)

4.1

2.1 2.0 1.9

3.22.5

3.4 3.1

0.6 0.3

-0.6

-2.2

-7.9 -8.0

-0.5

3.7

1.6 1.5

9.3

-0.2 -0.6

1.5

4.8 4.95.6 5.5

4.0

5.4

3.5

1.1

-2.1-2.7

1.7

3.84.8

5.6 5.95.0

7.2

4.7

3.5 3.4

1.6

1.4

1.73.0

1.82.2

-10

-8

-6

-4

-2

0

2

4

6

8

10

Advanced Economies

Israel

%

-The Quarterly data show the seasonally adjusted rate of change from the previous quarter at an annualized rate.-The growth rate for the advanced OECD economies (excluding Luxembourg and Iceland) is a simple average of their individual growth rates.

SOURCE: OECD Data and the Bank of Israel

9

%

Israel’s Annual GDP Growth RatesIsrael’s Annual GDP Growth Rates))20002000 – – 2012F2012F((

Bank of Israel forecasts for 2012

2.8

4.84.8

0.8

4.0

5.55.64.94.8

1.5

-0.6

-0.2

9.3

-2

0

2

4

6

8

10

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

F

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

01/0

007

/0001

/0107

/0101

/0207

/0201

/0307

/0301

/0407

/0401

/0507

/0501

/0607

/0601

/0707

/0701

/0807

/0801

/0907

/0901

/1007

/1001

/1107

/11

10

Goods imports and exports*(2000–2011)

* Monthly figures, $ million, at current prices. Imports and exports excluding airplanes, ships and diamonds.SOURCE: Bank of Israel.

Goods Exports

Goods Imports

$millions $millions

11

Main labor market Indicators (Quarterly data, seasonally adujsted,1997-2011)

%

SOURCE: Based on Central Bureau of Statistics Labour Force Survey.

57.4

5.6

%

54.2

5

6

7

8

9

10

11

12

45

47

49

51

53

55

57

59

Unemployment Rate Participation Rate Employment Rate

12

Real Wage per Employee PostReal Wage per Employee Post**))1999-20111999-2011((

*Seasonally adjusted, 3 months moving average. 2004 prices.

5700

6200

6700

7200

7700

Total Public services Business sector

SOURCE: Based on Central Bureau of Statistics Data.

13

-5.0 -4.9

-3.0

-0.9

-1.7 -1.6 -1.7-1.1

0.5

1.7

3.1

0.9

3.62.9

0.3

2.7

4.8

-6

-4

-2

0

2

4

6

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Current Account of Balance of PaymentsCurrent Account of Balance of Payments(Percentage of GDP, 1995-2011)(Percentage of GDP, 1995-2011)

SOURCE: Balance of Payments, Central Bureau of Statistics.

%

14

%

Budget Deficit** (Percent of GDP, 2000-2012**)

*Percent of GDP; excluding credit extended. The data refers to the deficit excluding the Bank of Israel’s profits.**2011 and 2012 Budget deficit is based on the current budget and BOI forecast.

3.53.2

2.0

3.0

3.6

1.8

3.9

3.0

4.0

3.43.0 2.9

1.6

6.0

5.5

1.4

4.0

5.0

5.8

4.0

2.4

1.0

0.2

2.0

5.0

3.4

0

1

2

3

4

5

6

7Deficit Target Actual Deficit

43

%

Budget Deficit**(Percent of GDP, 2000-2012**)

*Percent of GDP; excluding credit extended. The data refers to the deficit excluding the Bank of Israel’s profits.**2011 and 2012 Budget deficit is based on the current budget and BOI forecast.

3.53.2

2.0

3.0

3.6

1.8

3.9

3.0

4.0

3.43.0 2.9

1.6

6.0

5.5

1.4

4.0

5.0

5.8

4.0

2.4

1.0

0.2

2.0

5.0

3.4

0

1

2

3

4

5

6

7Deficit Target Actual Deficit

16

%

Gross Public DebtGross Public Debt((Percent of GDP, 2000-2012F) 2000-2012F)

*Bank of Israel forecast

84.389.0

99.393.7

84.779.4 76.1 75.3 75.5

96.7 97.7

77.078.1

0

20

40

60

80

100

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011F 2012F

17

34.232.3

0

10

20

30

40

50

Mex

icoChile

United S

tate

s

Korea

Turkey

Irela

nd

Slova

k Rep

ublic

Switz

erla

nd

Greec

e

Canad

a

Portugal

New Z

eala

nd

SpainIs

rael

Estonia

OECD

Czech

Rep

ublic

United K

ingdom

Icel

and

Germ

any

Luxem

bourg

Hungary

Slove

nia

Austria

Finla

nd

Norway

France

Italy

Belgiu

m

Swed

en

Denm

ark

The Tax Burden in Israel The Tax Burden in Israel and in the OECD Countries and in the OECD Countries

(Percent of GDP, 2010)(Percent of GDP, 2010)

Including income tax, social security tax, fees, levies and fines, Including consumption taxes, levies on specific goods & services and valued added taxes. SOURCE: OECD data

%

18

-3

-2

-1

0

1

2

3

4

5

6

Bank of Israel interest rateActual inflation

%

Inflation expectations

The Bank of Israel Interest Rate, Actual Inflation,* and Inflation Expectations**

) 2004–12(

*In the previous twelve months. **Twelve months forward, calculated form the capital market.

SOURCE: Bank of Israel.

19

Inflation Over Past 12 Months, Inflation TargetsInflation Over Past 12 Months, Inflation Targets

and Inflation Expectations from the Capital Marketand Inflation Expectations from the Capital Market ))1997-20111997-2011((

-3

-1

1

3

5

7

9

11

Inflation expectations

Consumer price index

SOURCE: Research Department, Bank of Israel

%

20

1010 Year Break-Even Inflation Expectations*Year Break-Even Inflation Expectations* (2001-2012)(2001-2012)

0

1

2

3

4

5

6

7%

10 years average Inflation Expectation.

SOURCE: Research Department, Bank of Israel

21

90

95

100

105

110

115

120

125

130

135

90

95

100

105

110

115

120

125

130

135

3.0

3.23.4

3.6

3.84.0

4.2

4.4

4.64.8

5.0

3.0

3.23.4

3.6

3.84.0

4.2

4.4

4.64.8

5.0

The Nominal and the Real Exchange RatesThe Nominal and the Real Exchange Rates(1997-2012)(1997-2012)

Shekel / Dollar Exchange Rate

The Real Exchange Rate by

Trading Partners (100=01/1997) 111.8

NIS

Ø The NIS/$ chart is on a daily basis, while the real exchange rate chart is on a monthly basis.

•A rise in the index indicates depreciation.

•The figure for the last month is calculated from spot exchange rates known for the half-month, our forecast CPI from the monthly model, and an extrapolation of inflation in the countries whose currencies are in the currency basket.

•SOURCE: IFS and Bank of Israel

Index

3.8

22The EMBI+ tracks total return for traded external debt instruments in the emerging markets. The EMBI + expands upon the original EMBI index which covered only Brady Bonds.SOURCE: Bank of Israel

10 Year Israel-US Gov. Bond Spread

and EMBI+ Index (Basis points 2006-2012,)

50

150

250

350

450

550

650

750

EMBI+ Israel-USA Government Bonds 10 Years Spread

23

The Stock Markets: Israel, NASDAQ and the Emerging Markets

(1/6/2006=100)

55

65

75

85

95

105

115

125

135

145

155

165

175

Emerging Markets

Israel (Tel Aviv 100)

NASDAQ

SOURCE: Bloomberg

Index

Credit Balances OutstandingCredit Balances Outstanding(2006-2011, NIS Billion)(2006-2011, NIS Billion)

Credit from the Banking SectorCredit from the Banking Sector(2006-2011, NIS Billion)(2006-2011, NIS Billion)

Credit to the Business SectorCredit to the Business Sector(2006-2011, NIS Billion)(2006-2011, NIS Billion)

80

Main labor market Indicators(Quarterly data, seasonally adujsted,1997-2011)

%

5

6

7

8

9

10

11

12

45

47

49

51

53

55

57

59

Unemployment Rate Participation Rate Employment Rate

SOURCE: Based on Central Bureau of Statistics Labour Force Survey.

54.2

%

57.4

5.6

43

%

Budget Deficit**(Percent of GDP, 2000-2012**)

*Percent of GDP; excluding credit extended. The data refers to the deficit excluding the Bank of Israel’s profits.**2011 and 2012 Budget deficit is based on the current budget and BOI forecast.

3.53.2

2.0

3.0

3.6

1.8

3.9

3.0

4.0

3.43.0 2.9

1.6

6.0

5.5

1.4

4.0

5.0

5.8

4.0

2.4

1.0

0.2

2.0

5.0

3.4

0

1

2

3

4

5

6

7Deficit Target Actual Deficit

Real Price of Housing (Relative to the CPI)Jan. 1973 - Oct. 2011, Index, Jan. 2000 = 1

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Jan-73

Jan-75

Jan-77

Jan-79

Jan-81

Jan-83

Jan-85

Jan-87

Jan-89

Jan-91

Jan-93

Jan-95

Jan-97

Jan-99

Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Credit Balances OutstandingCredit Balances Outstanding(2006(2006--2011, NIS Billion)2011, NIS Billion)