Inflation, Unemployment, the Exchange Rate, and Monetary Policy in Israel, 1990–99: A SVAR Approach

29 Pages Posted: 7 Nov 2012

See all articles by Joseph Djivre

Joseph Djivre

Bank of Israel

Sigal Ribon

Bank of Israel - Research Department

Date Written: 2003

Abstract

In this paper we examine the effect of monetary policy on the Israeli economy, and in particular on unemployment and the evolution of prices, for the period between 1990 and 1999, using the SVAR methodology. The four endogenous variables are the unemployment rate in deviations from its trend, the inflation rate, the Bank of Israel nominal interest rate and local-currency depreciation. We posit two models. In the first the identification restrictions imply that aggregate supply does not respond immediately to changes in aggregate demand, while in the second the aggregate supply response to demand shocks has been designed to have the maximum effect. The impulse response function analysis in both models indicates that an unexpected tightening of monetary policy is followed by a relatively fast slowdown in the inflation rate and a rise in the unemployment rate. This result differs from the findings in other empirical work concerning relatively large closed economies in which prices respond with a delay to policy changes, lagging behind the output response.

The analysis of the actual structural shocks during the period surveyed indicates that supply shocks are the main reason why unemployment deviates from its long-term level. The contribution of monetary policy shocks to the evolution of unemployment between 1993 and 1994 and after 1997 in the context of the second model is in line with existing appraisals of monetary policy, according to which it was loose in the first sub-period and tighter in the second one. It may therefore be inferred that this model, which is characterized by nominal frictions, is more suitable for describing Israel’s economy during the estimation period.

Suggested Citation

Djivre, Joseph and Ribon, Sigal, Inflation, Unemployment, the Exchange Rate, and Monetary Policy in Israel, 1990–99: A SVAR Approach (2003). Israel Economic Review, Vol. 1, No. 2, 2003, Available at SSRN: https://ssrn.com/abstract=2171835

Joseph Djivre

Bank of Israel ( email )

P.O. Box 780
Jerusalem, 91907
Israel

Sigal Ribon (Contact Author)

Bank of Israel - Research Department ( email )

PO Box 780
Jerusalem 91007
Israel

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