Almost 20 years have passed since the annual inflation target range was set – between 1% -3%. As revealed in Globes, the Bank of Israel is now examining a dramatic move to change the inflation target. Last week, the bank invited the public to submit an opinion on the matter. If they then come to the conclusion that there is room to change the current target, the bank will recommend to the government to act accordingly.
Who sets an inflation target?
The inflation target in Israel is not defined by law, but is determined by a government decision in consultation with the governor. The government sets a target for price stability and the bank is committed to striving to achieve it. The inflation target was first set in Israel in 1992 and over the years it has been only partially met. Since 2014, inflation has not once been at the bottom of the inflation range. Over the years there have been anomalies, but it can be said that the destination has gained high credibility.
Does an exception justify a change in interest rates?
The first goal of the Bank of Israel is to maintain price stability in the economy, among other things through interest rate tools. The price stability target is the inflation target, which reached 2.8% last month – near the upper limit of the inflation target range set by the Bank of Israel. If you ask the central bank on weekdays – inflation is not necessarily a bad thing, on the contrary. Still, there is a fear of losing control that could cause the central bank to be dragged after the market.
The Bank of Israel does not expect an increase in the interest rate, even in the event of a deviation from the target, on the assumption that inflation will fall back to the middle of the target range this year. The Bank of Israel boasts a “luxury” of low inflation relative to other countries in the world.
Why change the target?
The inflation target has an impact on inflation expectations, and therefore it affects monetary policy. Assume that the inflation target in Israel was 2%, and not 1% – 3%, and suppose the target was rigid and inflexible, the Bank of Israel should have raised interest rates since inflation exceeded the target. In practice in recent years, the dilemma has been quite the opposite. Until recently, before the corona crisis, inflation exceeded the target from below and was below 1%, which supported monetary expansions that inflated real estate prices.
Why exactly do you want to change now?
It is difficult to ignore the fact that inflation is now threatening to exceed the target set by the Bank of Israel, and the market expects the Bank of Israel to raise interest rates in April. Re-examining the inflation target is an attempt to create more flexibility for raising interest rates in relation to the rate of rise in prices in the economy. However, the Bank of Israel explains that the process began at a time when inflation was relatively low, and the decisions that will ultimately be made will not be affected by inflation in the short term.
Is the target targeting inflation or is it targeting the target?
The European Central Bank (ECB) last year changed the inflation target from a low level but close to 2%, to a symmetrical point target of 2% inflation. The US Fed even went so far as to state that its target is an average inflation rate of 2%. Fed economists did not imagine that reality would turn on them so quickly, inflation would soar to 7.5%, and the average target would now be at their backs. Perhaps the Bank of Israel dropped the token that the economists at the Fed were wrong and even had political motives.
Is there a connection to the cost of living?
According to Victor Behar, director of Bank Hapoalim’s economics department, inflation has become more volatile, and there is a growing feeling that the price index alone does not reflect all price changes. Therefore, there is an advantage in setting an inflation target with a wide range without striving for any number in this area (symmetrical target), all the more so without any average over time similar to the US. , Explains Mt. “In my opinion, in the test of the result, these goals undermine the credibility of the target. This is especially noticeable in the United States – to balance 7.5 percent inflation will require years of zero inflation and it is quite clear that the Fed is not aiming for that. A symmetrical target with a forgetfulness feature is also problematic, and we see that the ECB is not currently working vigorously to reduce inflation to 2%. A goal that is a field, allows for more flexibility and consideration of factors such as asset prices and financial markets. “
Is the bank aiming for price increases?
Behar explains that central banks do not like an inflation target that starts from scratch, because of an old perception that measuring inflation is skewed upwards. “Zero inflation was perceived as a risk, partly due to estimates that technological improvements do not find adequate expression in the index and there is an upward bias in the measurement,” he explains. “In today’s reality we can name quite a few factors that drop the index down, and the gap between public sentiment and inflation data is high (and not unique to Israel). Many measurement difficulties in the world of frequent technological changes, so in my opinion the target should include zero.”
Why did a call come out to the public?
The Bank has previously received opinions from the public on cellular payments, clearing infrastructure, the issuance of digital currency, and is now examining the inflation target. Market economists think this is an accepted procedure, and research bodies in investment houses or universities are given the opportunity to present their position on the subject.