Travel Reference
In-Depth Information
Monetary Policy
The responsibility for maintaining price stability falls on the Bank of Israel, the country's central
bank, the equivalent to the U.S. Federal Reserve. Like its peers, the Bank of Israel seeks to stabi-
lize prices by controlling the amount of money circulating in the economy (money supply) and
the short-term interest rates. Interest rates that are too low encourage the economy to expand
too quickly and contribute to infl ation. Conversely, rates that are too high can choke off eco-
nomic growth. The bank was set up in 1954, but for the fi rst thirty years of is existence, its ability
to ensure price stability was severely constricted. It operated principally by raising and lowering
the amount of money it required the banks to put on deposit (the reserve requirement).
Since 1985, however, the Bank of Israel has gradually adopted the same set of tools for
controlling money supply used by other central banks in the developed world. The foremost
of these are monetary auctions, in which the country's commercial banks bid for deposits or
loans from the central bank, thereby setting a baseline for the lowest rate of interest in the
economy. Another tool is
Makams
(short-term loans, called by their Hebrew acronym), which
are bonds issued by the central bank for terms of up to one year. By issuing Makams, the Bank
of Israel ties up the cash used to purchase them for a year; buying them back or letting them
mature has the reverse effect. Since 1992 the government has set an infl ation target, which
defi nes the boundaries of “acceptable” infl ation. In recent years, the target has been set at 1 to
3 percent annually.
The Shekel and the Exchange-Rate Policy
The legal tender of pre-state Palestine and Israel has gone through several changes over the
past century. Under Ottoman rule, Turkish currency was the offi cial medium of exchange, and
it remained so after the British conquered Palestine (although the Mandate authorities also let
the Egyptian pound circulate, as Egypt was then under British rule as well). In 1927, Palestine
got its own currency, the Palestinian pound, which was linked to the British pound.
In a move that would have long-term implications for the Israeli economy, Britain imposed
exchange controls on the Palestinian pound during World War II. These remained in effect
after the war and were adopted by Israel when it was declared a state in 1948. Even as Israel
moved to its own currency, the lira, and later to the shekel and the new shekel, exchange con-
trols remained in force to one degree or another —with two brief interruptions —until 2005.
Exchange or currency controls set rules about who can buy and sell foreign currency at
what price and for what purposes. The idea behind them is that in an economy that has limited
foreign currency assets, the government should allocate them where they are most critically
needed (for instance, to support food imports instead of vacations abroad). Indeed, it might
even use the exchange rate to foster other economic policies, such as making exports more
price competitive by reducing the currency's international value (a devaluation).
Many governments, including Israel's, have imposed multiple exchange rates, setting their
currency's value at different rates depending on the purpose for which it is being bought or
sold. Of course, the value of a currency hinges on a host of factors, such as infl ation and a
