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Discussion

Monetary policy and fiscal policy are the two key tools used to keep the nation’s economy healthy. The monetary policy is regarding keeping the goods and services’ prices stable. It influences the level of price- the inflation rate i.e., the economy’s aggregate price level. It is suitable to provide a more expansionary monetary policy when there is evidence that the inflation will fall or is falling below the level desired. The sovereign risk and inflation are key markers for the government’s credibility in the emerging markets (Bowman, Londono and Sapriza 2015).

Since 2000s, following some developed economies’ steps, various central banks in the emerging markets have gained independence from the government and have improved their overall credibility through winning over their historically high inflation rate. In these nations, monetary policy now largely includes setting up of the nominal rates of interest to target inflation. Further, over the last few decades, there is major changes in the way economy works because of the globalization, global financial crisis 2008, and the covid-19 pandemic. These have highly affected the economy of the emerging economies and the response towards the challenges (Fratzscher and Rieth 2019). Hence, this report aims to critically evaluate how monetary policy can be used to support an economy of Israel.

The BoI has kept its rate of interest at the low of 0.1 percent for the fifteenth policy meeting held on February 21, 2022. This is in line with the expectations of the market, but the bank also noted that the situations in the coming period, will require to commence a gradual process of increasing the rates of interest. Amid the rapid vaccination roll-out of the covid-19, in which already 46 percent of the Israelis have received the booster dose, the GDP of the country increased by 8.1 percent in 2021. For the 1st time, after the covid-19 outbreak, the GDP level surpassed its before-crisis trend line. Further, in February, the yearly inflation rate increased to over 3.1 percent from the rate of 2.8 percent in January, over the upper bound target range of over 1 percent to 3 percent that is more than the estimates of market. It is projected that the inflation will continue to be around the target range’s upper limit in the coming period, and will likely to fall afterwards towards the target range’s midpoint. 

Israel Interest Rate

Figure 1: Israel Interest Rate (Tradingeconomics.com. 2022).

Israel Continual Monetary Policy

The BoI has maintained its dovish attitude, stating that it is ready to expand the uses of the existing tools, comprising the interest rate tool, and if necessary, will use the additional ones. The bank stated that the risks continue to be high, despite accelerating the pace of the vaccination drive. Further monetary easing is likely to go forward, though it will expect to be delivered through the non-conventional means (Focus-economics.com. 2021).

Israel’s yearly economic growth of is around 3.5 percent over the last few decades, which has been mainly an outcome of the increased rates of employment, despite the fact that the rate of productivity growth has been quite low. Further, the rates of employment cannot remain increase at this particular rate in the future because of the likely saturation point in the rates of employment among this nation’s non-ultra-Orthodox overall Jewish population. Further, despite this, attaining optimistic employment goals among the sectors having presently low participation rates will not help in avoiding a fall in the growth of the GDP rate to the historically low rate of about 2.3 percent annually. The GDP per capita rate of Israel is not at the level compared to the other OECD nations. It is the reason why this gap has not changed for around forty years. In absence of the reforms to upsurge the rate of productivity growth, the relative GDP per capita of Israel is likely to fall (Eckstein, Lifschitz and Menahem-Carmi 2020).  

GDP Growth of Israel

Figure 2: GDP Growth of Israel (Data.worldbank.org. 2021).

In case of the present scenario, the GDP in Israel has expanded in the Q4 of 2021 over the last quarter, which is slightly faster than the estimate of 3.9% and speeding up from upward 1.7% increase in the Q3. The economic growth in Israel is expected to be slow from 2021, but will continue to be solid, sustained by a booming technology scene, the recovering tourism industry, and strengthening ties with the Gulf neighbors. However, the likely unrest in Palestine, tense relationship with Iran and shortages of labor, and the government’s fragmented nature are posing downside risks to the overall outlook.

The primary function of the BoI is to protect the local currency’s value, and maintain the price stability. The BoI is the central bank of Israel, which aims to maintain financial system stability and price stability in Israel. Additional functions of the BoI are supporting the achievement of the gaps’ goals, and the stability and suitable financial system’s activity. These provides that the price stability is not affected in the long-term. The BoI aims to maintain the money value, since it is vital for the economic strength and stability, as well as for making the situations essential for the sustained growth of the employment and output (Boi.org.il. 2022).

Economic Performance of Israel

The BoI also take measures of avoiding the high inflation by using the tools of monetary policy, if required. In consultation with the central bank’s Governor, the government of Israel sets the target of price stability, which is the annual increase rate in the CPI. At present, the target range is between one to three percent annually, and BoI is responsible to attain that goal of maintaining the target range. There are some of the goods and services’ prices that will rise by less, or other by more, but the main purpose is that the prices of goods and services comprised in the CPI will on an average increase at the rate within the target range. The main objective is not to attain as low rate of inflation as possible. The lessening deviation from the target set is thought in the same way as the increased deviation (Agoba et al. 2017).

The monetary policy in Israel is also implemented and administered by the BoI, along with conducting operations of foreign exchange, regulates and supervised the banking system, manages foreign reserves, and also manages the financial market operations. For meeting the objective of price stability, the BoI implements number of the policy instruments, such as the short-term rate of interest that is set by the monetary committee that is controlled by the governor. Further, the BoI sets the interest rate at the level, which will maintain the inflation rate within the target range, or will help the inflation rate to return to its target range in the period that is no more than 2 years. This bank is quite independent to set the interest rate of short-term and use monetary instruments to meet its overall goal. It increases the interest rate during inflation, and lowers the rate of interest during the period of economic standstill and recession, when there is no such inflationary pressure (Boi.org.il. 2022).

Over the last few years, Israel has undergone through the substantial changes in the monetary policy terms, regulation of exchange rate, and the overall financial structure. Israel has been facing various economic challenges over the years such as the economic shock during the Great Financial Crisis 2008, and now the covid-19 pandemic (Takáts. and Vela 2014).

The channel of interest rate is mainly emphasized by the money-view, which assumes that there are just two assets in the economy that are bonds and currency. Bonds are all the other financial assets that are held as a store of value, and currency is used for the transactions. By raising the official rate, the monetary authorities induce a fall in the banking system reserves’ amount, and hence, contraction in the banks’ issued deposits. Hence, the money view assumes that the monetary policy results in affecting the output through decrease in the real money balances detained by the private sector and through a reduction in all the expenditures that are interest-sensitive (Fiore 2022).

Role of Central Monetary Authority of Israel

A credit view highlights the significance of the lending channel of bank as a transmission mechanism. This view states that the bank loans are mainly considered as the third kind of asset, along with the bonds and money. When a restrictive monetary policy is introduced, the banking system reserves’ amount reduces, so that the ability of bank to lend is also reduced (Kohlscheen and Miyajima 2015). Lastly, it is argued that the channel of exchange rate is the additional transmission mechanism by referring to the exchange rate asset theory. It states that when there is flexible exchange rate, the foreign reserves are fixed and the rate of exchange is determined by the long-run consideration, for instance, purchasing power parity (Aguir 2018).

There is a major covid-19 impact on the monetary policy’s transmission to the financial markets. An outbreak of the covid-19 has made the monetary policy’s transmission quite vulnerable. The unconventional monetary policies have found to be more effective during the crisis, as they can negatively affect the stock markets and exchange rate to some extent. For instance, the BoI provided some relaxation of the mortgage lending rules against the backdrop of the covid-19 pandemic on April 2021. Post covid-19 crisis, much stronger monetary policy is required to drive the financial markets, and the other macro-economic measures may be required to attain the intended outcome (Wei and Han 2021).

 Forecast

Figure 3: Forecast (Bnpparibas.com. 2017). 

Inflation and the Monetary Policy

Figure 4: Inflation and the Monetary Policy (Bnpparibas.com. 2017).

The core inflation rate of Israel has held significantly below the target range of the BoI over the years. While there are number of factors that are expected to boost the inflationary pressures in the short-run, the inflation expectation of the market remains anchored within the target range of the central bank. In 2017, the economic growth of the country has slowed down in comparison to the past years. The purchasing power gains and buoyant labor market will remain support the consumption of household that must facilitate growth to slightly accelerate to 3.5 percent. Further, after the significant decline in the country’s fiscal deficit, the government must be able to cut the tax (Goldscheider 2019).  

Foreign Exchange Reserves of the BoI

Figure 5: Foreign Exchange Reserves of the BoI (Bnpparibas.com. 2017).

Alongside the low interest rate policy, the BoI is proceeding with the intervention of the forex market to limit the appreciation of skekel. The BoI believes this policy to be effective. Since the year 2013, the BoI purchase of every USD 100 m tranche, has assisted to contain an average appreciation of the USDILS within the range of 0.8 percent and 1.4 percent between the year 2013 and 2016. These purchases have been attempted to offset the natural gas production’s impact on the imports of energy. Further, increase in the foreign reserves of the central bank is significantly contributing to the growth of money supply. Moreover, the shekel is likely to appreciate in the medium term (Eichenbaum, Johannsen and Rebelo 2021)

Transmission Mechanisms of Israel Monetary Policy

Conclusion

Therefore, it can be concluded that the annual inflation rate of Israel has been increased over the years, which is expected to fall in the coming periods. The GDP of the country has increased by 8.1 percent amid the increasing covid-19 crisis and covid-19 vaccination roll-out. Further, it has been analyzed that Israel economic growth over the past few decades, has been mainly an outcome of the increased employment rates, even though having lower productivity. The economic growth is quite low compared to the other OECD nations. Moreover, it has been analyzed that the main role of the Israel Central Monetary authority is to maintain the price stability, avoid the high inflation, support the government in attaining the economic growth, and ensuring proper activity and stability of the financial system by using macro-economic tools, when required. It has been analyzed that Israel has undergone through the substantial changes in respect of the monetary policy, exchange rate regulation, and financial structure, such as the GFC and the continuing covid-19 impact.

Reference

Agoba, A.M., Abor, J., Osei, K.A. and Sa-Aadu, J., 2017. Central bank independence and inflation in Africa: The role of financial systems and institutional quality. Central Bank Review, 17(4), pp.131-146.

Aguir, A., 2018. Central bank credibility, independence, and monetary policy. Journal of Central Banking Theory and Practice, 7(3), pp.91-110.

Bnpparibas.com. 2022. Monetary policy status quo. [online] Available at:

<https://economic-research.bnpparibas.com/html/en-US/Monetary-policy-status-1/30/2018,30610> [Accessed 10 March 2022].

Boi.org.il. 2022. Bank of Israel - Monetary Policy Framework - Conducting Monetary Policy. [online] Available at:

<https://www.boi.org.il/en/MonetaryPolicy/MonetaryPolicyFramework/Pages/Default.aspx> [Accessed 10 March 2022].

Bowman, D., Londono, J.M. and Sapriza, H., 2015. US unconventional monetary policy and transmission to emerging market economies. Journal of International Money and Finance, 55, pp.27-59.

Data.worldbank.org. 2021. GDP growth (annual %) - Israel | Data. [online] Available at:

<https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=IL> [Accessed 10 March 2022].

Eckstein, Z., Lifschitz, A. and Menahem-Carmi, S., 2020. A growth strategy for the Israeli economy. [online] Brookings. Available at: <https://www.brookings.edu/research/a-growth-strategy-for-the-israeli-economy/> [Accessed 10 March 2022].

Eichenbaum, M.S., Johannsen, B.K. and Rebelo, S.T., 2021. Monetary policy and the predictability of nominal exchange rates. The Review of Economic Studies, 88(1), pp.192-228.

Fiore, F., 2022. The Transmission of Monetary Policy in Israel. [online] imfsg. Available at:

<https://www.elibrary.imf.org/view/journals/001/1998/114/article-A001-en.xml> [Accessed 10 March 2022].

Focus-economics.com. 2021. FocusEconomics | Economic Forecasts from the World's Leading Economists. Israel Monetary Policy January 2021. [online] Available at:

<https://www.focus-economics.com/countries/israel/news/monetary-policy/bank-of-israel-leaves-policy-unchanged-in-january> [Accessed 10 March 2022].

Fratzscher, M. and Rieth, M., 2019. Monetary policy, bank bailouts and the sovereign-bank risk nexus in the euro area. Review of Finance, 23(4), pp.745-775.

Goldscheider, C., 2019. Israel's changing society: Population, ethnicity, and development. Routledge.

Kohlscheen, E. and Miyajima, K., 2015. The transmission of monetary policy in EMEs in a changing financial environment: a longitudinal analysis.

Takáts, E. and Vela, A., 2014. International monetary policy transmission. BIS paper, (78b).

Tradingeconomics.com. 2022. Israel Interest Rate - 2022 Data - 1996-2021 Historical - 2023 Forecast - Calendar. [online] Available at: <https://tradingeconomics.com/israel/interest-rate> [Accessed 10 March 2022].

Wei, X. and Han, L., 2021. The impact of COVID-19 pandemic on transmission of monetary policy to financial markets. International Review of Financial Analysis, 74, p.101705.

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