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BANK OF ISRAEL
Office of the Spokesperson and Economic Information
January 13, 2015
Press Release
The effect of fiscal policy, monetary policy and the global economy on real
yields of Israeli government bonds
 The public debt to GDP ratio has a statistically significant effect on real yields of
government bonds in Israel. The effect is greater the longer the bond’s term to
maturity is.
 Monetary policy has a marked effect on shorter yields, but also a statistically
significant, if small, effect on long term yields.
 The global financial environment, reflected by yields on US government bonds,
has an effect on domestic real yields for all horizons; this effect has strengthened
in the past decade.
 The effect of government debt on yields in Israel has also strengthened in the
past decade: since the breaking out of the global crisis, a 1 percentage point
increase in the ratio of government debt to potential GDP acts to increase the 10year yield by about 10 basis points.
 The decline in the Bank of Israel interest rate explains a notable part of the
decline in short term and medium term yields that occurred in the middle of the
previous decade, while the decline in government debt explains a large part of
the decline in longer term yields.
Fiscal policy, monetary policy, and the global economic environment affect government
bond yields in Israel. Monetary policy is the dominant factor affecting short term yields,
fiscal policy especially impacts on longer term yields, while the global economic
environment—as reflected by US government bond yields and by the VIX index of
equity market volatility—impacts on domestic real yields for all horizons. These are
among the findings of a new research paper by Dr. Adi Brender and Dr. Sigal Ribon of
the Bank of Israel’s Research Department. Their research also examined the changes over
Bank of Israel - Research - The effect of fiscal policy, monetary policy and the global economy on real
yields of Israeli government bonds (Jan. 2015)
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time in the factors impacting on the yields, and found that the effects of government debt
and US yields strengthened over the past decade.
An examination of the effect of fiscal policy variables on yields indicates that the
dominant variable is the public debt to GDP ratio—an increase of 1 percentage point
acted, over the course of the sample period (2001 through September 2013), to increase
the 1-year yield by 4 basis points (0.04 percentage points) on average, and to increase the
10-year yield by 7 basis points. This effect has strengthened over the past decade, and in
the period since the global economic crisis broke out, it has reached about 10 basis points
for the 10-year yield. The current research did not find a statistically significant effect of
the forecast deficit or the deficit target on yields, in contrast to the study authors’
previous research, which examined data for an earlier period and found such an effect.
The implication is that the effect of fiscal policy on yields is expressed through an
extended deficit which is reflected in accumulated debt that leads to an increased burden
of interest payments, due to both the increase in the debt itself and the increase in yields,
and not through short term fluctuations in the deficit.
The paper finds that unexpected changes in the Bank of Israel interest rate have a greater
impact on bond yields than changes that could be forecast by an econometric equation. It
was found that monetary policy has a dominant effect on interest rates for the short term,
but that it also a statistically significant effect on the long term yield—including the
effect of (unexpected) interest rate changes on the 5–10 year forward yields.
The effect of the global economy on yields was measured in the paper by two variables
that were found to contribute to the explanation: the real yield on US government bonds
and the VIX volatility index of US equities. These two variables are positively correlated
with yields in Israel, and the effect of the US yield has also intensified to a statistically
significant extent during the past decade. In addition to the direct channel, the US interest
rate also has an indirect effect on yields in Israel, via the effect on the Bank of Israel
interest rate.
An analysis of the factors that affected the development of yields in Israel in the past
decade indicates that the decline in the monetary interest rate explains most of the decline
in short term yields, while fiscal policy explains most of the decline in long term yields
(Figure 1). The breakdown of the factors impacting on the interest rate, between domestic
and global elements, shows that global factors had a marked effect on the decline in
yields for all maturities, and that the effect intensified in the second half of the decade
(Figure 2).
Bank of Israel - Research - The effect of fiscal policy, monetary policy and the global economy on real
yields of Israeli government bonds (Jan. 2015)
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Figure 1
Contributions to change in real yields in three time periods, 2001–2013:9
Figure 2
Contribution of domestic and global factors to change in real yields in three time
periods, 2001–2013:9
Bank of Israel - Research - The effect of fiscal policy, monetary policy and the global economy on real
yields of Israeli government bonds (Jan. 2015)
Page 3 Of3