111 Monetary policy in the recovery process Prof. Zvi Eckstein Deputy Governor, Bank of Israel YPO

2 Outline The Israeli Macro Economic Monetary Policy Israel Industry Challenges

333 % 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” shaped Growth rates Israel, US and Europe (Quarterly rates in annual terms)

444 Unemployment rates Israel, US and Europe % Source: OECD Stat *Annual forecast by B.O.I

5 World Financial Conditions: Libor and banks’ CDS spread World Financial Conditions: Libor and banks’ 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 Fiscal Policy Public spending (right) Deficit (right) Debt (left) New Fiscal Rule (2011 – on):New Fiscal Rule (2011 – on): Increase in expenditure = Increase in expenditure = [60/(Debt/GDP)] * Ave 10y growth Or decreasing Deficits as % of GDP (3, 2, 1). 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 objectives 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- targeting policy?

9 Interest rates of central banks EU, US, UK and Israel % Northern Rock Crisis begins Lehman Brothers collapse UK Israel EU US JAPAN

10 % Lehman Brothers collapse Annual inflation and expected inflation 10 year market derived inflationary expectations Source: BOI

11 Interest rate and year-on-year inflation fan charts Inflation BOI interest rate

12 Back to growth: a slow process of 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

13 Balance of payments (quarterly) $ millions Exports of Goods and services (left) Imports of Goods and services (left) Current account (right) Source: BOI Exports Vs. Imports balance: Surplus in Capital AccountExports Vs. Imports balance: Surplus in Capital Account Result: A stable, strong ShekelResult: A stable, strong Shekel

14 NIS/Dollar exchange rate nominal-effective and real-effective exchange rates NIS/$ (right) Nominal-effective (left) IndexNIS 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 policy: Short run – Slow process of returning to normality

16 Israel Industry High Share of High Tech High correlation with International Trade Low innovation in traditional industry Problem: Strong Shekel

17 Exports by technology intensity $ millions Source: BOI

18 Industrial production by technological intensity Source: Makov report (2007), CBS (Israel 2008). EU average: Italy, Belgium, Denmark, Finland and France.

19 Industry: GDP, productivity, capital per worker and R&D: Israel/USA R&DCapital per worker Total Factor productivity GDP per worker 42%97%44%56% Low and medium- low technology 42%89%52%53% Medium and medium-high technology 113%102%66%89% High technology 98%94%59%63% All industry Source: Makov report on enhancing the periphery and low-technology industry (2007)

20 Challenges Low participation and poverty Education Peace and economy

21 Thank you!