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PAPERS
Debtand MacrooonomIcAdjustnent
Country
Economics
Department
TheWorldBank
September
1988
WPS91
Public Disclosure Authorized
Public Disclosure Authorized
Public Disclosure Authorized
Public Disclosure Authorized
Poly, Planning,andR_ewch
Israel's Stabilization
Program
Nissan Liviatan
A disinflation strategy that involved eliminatingthe fiscal deficit and changing
the rules of the government-labor game reduced inflation,in Israel from more
than 400 percent a year in 1984to a low 20 percent a year in the third year of
the program.
TUePoicy. Planxing, nd Research Ccmplex disuibutes PPR Wo&kingPapes to disoininte the findings of work in progrss and to
in developmeritissues. These papers cany the names of
enaounge the exchange of ideas among Bank atuff and all others in=ed
the authors, reflect only their views, and should be used and cited accordingly.The findings, interpretations, and conclusions are the
authorsown.Iley should not be attibuted to theWorld Bank, its Board of Directors,its management. or any of its menber countries.
PlKPlanning, and R srch
Debt and Mlroownomc
Tlhestabilization program Israel launched in July
1985 combined orthodox fiscal and monetary
policies wiut a heterodox incomes policy.
The orthodox elements included a sharp
reduction in the fiscal-operational deficit - 8
percent of GNP in the first six months - and
tight monetary policy.
The heterodox element was to freeze wages
and prices and peg the exchange rate to the U.S.
dollar. Wage and price controls were relaxed in
1986 and 1987, leaving exchange rate policy
(later pegged to the basket of currencies) as the
anchor in the new system.
The national coalition government succeeded in neutralizing pressures for deficit
Adjustment|
srwending.Under government pressure, employers' organizations and organized labor reached a
wage agreement in July 1985 that prevented
substantial unemployment. This approach not intended for use in normal times - proved
effective in administering shock treatment.
The result? At the _nd of the program's
third year, inflation is running a low 20 percent
annually, compared with more than 400 percent
in 1984.
Whether stabilization will survive the
November 1988 elections remains to be seen.
The stabilization programs in Argentina (in
1985) and Mexico (in 1988) were similar in the
initial stages to Israel's.
This paper is a product of the Debt and Macroeconomic Adjustment Division,
Country Economics Department. Copies are available free from the World Bank,
1818 H Street NW, Washington DC 20433. Please contact Nissan Liviatan, room
N11-063, extension 61763.
'Ce PPR Working Paper Se1ies disseTninatesthe findings of work under way in the Bank's Policy, Planning,'and Research
Complex. An objective of the series is to get these findings out quiclcly,even if presentations are less than fully polished.
The Suldings,interpretations, and conclusions in these papers do not necessarily represent official policy of the Bank.
Copyright i) 1988 by the International Banlcfor Reconstruction and Developmenflhe World Bank
Table of Contents
Psi.
Title
.
Introduction........
I.
.
The Current State of Stabilization
.
.
.
.
.
.
.
.
1
.. .
4
.
. . . .
1. The Nominal System
2. Real Effects of Disinflation
II.
The Change of Regimes. ................
1.
2.
3.
4.
S.
6.
7.
8.
9.
9
The InflationaryRegime
The Change in the Rules of the Game
The Focus on the externalPosition
The Effect of Reducing Inflationon Reserves
The Role of U.S. Aid
Real Aspects of fiscal Policies
FinancialAspects of the Fiscal Adjustment
Domestic Investmentand MonetaryPolicy
Summing Up the Influenceson the ExternalPosition
III. Evolution of Policiesin the Course of Stability
26
1. Fiscal Policy
2. Monetary Policy
3. ExchangeRate Policy
IV.
Policy Dilemmas..
.
.
.
.
..
.
.
.
29
1. The Low InflationStep
2. The Issue of Real Appreciation
..
Footnotes and References..
Tables
..
3. .
. .
Figures . . . . .
.
.
. .
.
.
.
. .
.
.
.
.
....
. .
..
..
.
.
36-38
39-47
. . . . . . .
..
. . . . . . . .
. . . . .
.
. . .
48-50
Introduction
Israel'sstabilizationprogram,which via launchedin July 1985, was
of the Oheterodoxsvariety, namely one which rombliedorthodoxelementswith
incomes policies. The orthodoxpart cQnsistedof a sharp reduction in the
fiscal (operational)deficit,of the order of 8Z of GNP in the first six
months, and a very tight monotary policy during this period. The heterodox
componenttook the form of an initialwage-price freeze which, togetherwith
pegging the exchange rate to the U.S. dollar brought about a sharp reduction
in lnflation- from around 152 per month in the first half of 1985 to 3.5Z in
August-Septemberand to 1.5-22 later on. Under the pressure of the goverrment
the workers' and employers'organizationsreached a wage agreement in July
1985 which signified the publlc's support for the program. Prices were made
more flexible and controlswere graduallyremoved in the course of 1986 and
1987.
Israel was not alone in followingthis type stabilizationstrategy.
The Austral program in Argentina (1985) and the recent stabilizationpolicy in
Mexico (1988) are of a similar variety,at least as far as the initial stages
are concerned. It is also very likely that future stabilizationprograms in
chronic inflationcountrieswill adopt a basically similar approach. The
intereit in the Israeli stabilizationprogram extends thereforebeyond its
domestic implications. This is especiallythe case since the program has been
doing quite well so far (as will be describedbelow).
-2-
Israel's stabilizationprogram is nearing now the end of its third
year ane inflation is still running at a low level of about 202 annually,as
comparedwith over 4002 in 1984. Disinflationis not supportedany more by
the comprehensivesystem of price controlswhich characterizedthe initial
phase and the coverageof controls teturnedto its normal level. The main
nominal anchor in the system is the exchangerate which was practicallyfixed
relativeto the basket of currenciessince the last devaluationof January
1987.
The year 1987 witnessed accelerationof growth in the economy which
was not accompaniedby any marked deteriorationin trade accoui
phenomenonwhich underminedmany exchange rate based stabilizations. The
current account was practicallybalanced in 1987 and reserveswere at record
high levels comparedwith recent years. The public sector'sbudget remai,Led
nearly balancedand the governmentinitiateda number of reforms in the area
of direct taxationand capitalmarket regulationswhich, togetherwith price
stability,contributedto the recoveryof domestic investmentafter years of
decline.
On a differentlevel, price stabilityhas become a political asset
which none of the major parties in the four-year-oldcoalitiongovernment
would wish to damage. In spite of the nearing electionsthe two major
partners in the coalitionhave acted more as watchdogs to each other, rather
than as competitorsin over spendingin their respectiveministries.
In this paper I shall try to analyze the major factorswhich made the
transitionto low inflationpossible. We shall deal with such issues as the
role of the U.S. aid and of domestic fiscal adjustment,of monetary and
.exchangerate policies and of the change in the rules of game concerning
government-laborinteractions. The paper will focus on the evaluationof the
-3-
program from the 1987 perspectivewithout devotingmuch space to the initial
heterodox shock which was described in various other papers. 11
From the point of view of this objectivethe data which summarize the
developmentsin 1987, which have now become available,are particularly
useful. This is so since this yas the first year in which the economy can be
said to have recoveredfrom the heterodox shock of July 1985 and adjusted to
the low inflationenvironment.
A related topic with which we shall be concerned is the evolutionof
the disinflationarypolicies in the course of the program. Here again the
1987 data will help us in diaentanglingthe transitoryfrom the more lasting
elementsof the Israeli disinflationstrategy.
In the final part of the paper we shall deal with the policy dilemmas
which face the governmentat the present stage of disinflation. In spite of
the rosy picture of 1987 one cannot ignore some problematic,
featuresof the
program. One disturbingfact is that the fixed exchange rate policy followed
in the past year and a half has not succeeded in reducingthe level of the
crawling inflationand consequentlya process of real appreciationhas been
taking place continuouely. This may have contributedto the recessionary
symptoms in the first half of 1988.
One of the main merits of the Israeli stabilizationwas its ability
to avoid a heavy cost in terms of unemploymentby adoptinga well-coordinated
heterodoxprogram based on a great degree of cooperationwith organized labor.
However,while this approachproved to be effective in administeringthe shock
treatmentit is not intendedto be used in the same way in normal times. It
is especially
high
after
the big achievement
of bringing
down inflationfrom a very
level that the public suspectsthat the governmentwill not fight to
eliminate
a low inflation
step.
This,
however,
may set an expectational
patternwhich may lead to unstable developments.
Much of the success in stabilizationwas due to the formationof the
national coalitiongovernmintwhich succeededin neutralizingpressures for
deficit spendingand wage increases. As the Novemberelections are
approachingthe ability to maintain the foregoingframeworkis put under
severe stressesthe outcome of which is still uinknown.These pressures are
already
domestic
in the preliminary
reflected
fiscal
deficit
The policy
since
issues
the last
involving
indicators
quarter
which show an increase
in the
of 1987.
the low inflation
step
and the real
appreciationwill be discussed towards the end of the paper. I shall begin
with a brief summaryof nominal and real effects of disinflationas viewed
from 1987 perspective.
I. The Current State of Stabilization
1.
The nominal
System
For the past two and a half years inflationhas been runnizig
at an
annual rate of about twenty percent. In the immediateperiod followingthe
July 1985 heterodox shock, over 902 of the consumer'sbasket was under price
controls,
in a frameworkof a wage-pricefreeze designedto break inflationary
inertia.
However, as a result of the decontrolprocesswhich started in the
beginningof 1986 the coveragewas reduced to 46Z in January 1987, while by
the end of that year only 20-25? of the consumers,basket was still
under
control. This correspondsto the traditionallevel of price controlswhich
covers some basic foodstuffs,governmentservicesand goverunentcontrolled
monopolies. Thus at the present stage controls (or the threat of their
reimposition)play only a minor role in keeping inflationat a low level.
The basic
nominal
the program is the exchange
anchor which supports
rate. Although the exclunge rate with respect to the basket of currencLeshas
been held practicallyfixed
to maintain
principle,
the exchange
rate
the government
7 the governmentis not commltted
since January
indefinitely
retains
: the present
the option
with the developoentin nominal wages if
of realigning
level.
In
the exchange
rate
it will deem it necessarytthis
optlon has not been excercisecihowever, in the past 18 months.
Since the beginningof the stabilizationprogram the public's
credibility
in the government'scommitmentto avoid inflationaryshocks has
increased.
One sign of this
is the average low level,
development
and lack of
trend, in the black dollar premium (see fig. 1).
The reduction
of inflationary
of the program is of course
reflected
expectations
following
the
initiation
in the sharp reductionin nomdnal
interestrates which is commensuratevith the reductionin inflation (see
table
1).
the level
While the nominal
of actual
inflation
interest
rates
the interest
on shekel deposits stabilizedat
rate
on credit
lines
in the
domesticmarket (denominatedin shekels)stabilizedat a higher level. The
meaning of the large spread 21 in interestrates (table 1) is not fully
understoodbut it presumablyreflectsmostly factorsnot related to
inflationaryexpectations(one of these
highly
respect
concentrated
banking
system and another
to activitiesin the domestic
The increase
are monopolistic
market).
practices
by the
is tight monetary policy with
31
in the weight of nominal (non-indexed)liquid Pssets iti
a coamon expressionof the reductionin inflationaryexpectations. The
continued growth of M 1 and H2 relativeto GNP (see table 2) indicatesa
growing confidencein the increasedprice stability.
-6-
It must be stressedthat the foregoingindicatorsreflect basically
short term attitudes and do not say much about the robustnessof the nominal
system to shocks. Some indicationin the latter directionwas the
surprisinglysmall effect of the January 1987 devaluation(of ten percent) on
the accelerationof inflationin the course of the year. One of the reasons
for this phenomenonwas the 'cooperative'nature of this devaluationto which
we shall return later on.
Another indicatorfor the robustnessof the nominal system concerns
the length of nominal contracts. The most significantindicatorin the area
Is the structureof the cost of living agreement. Here rsther slow progress
has been made, the main aspect of which was the increase in the trigger level
of inflation for COLA purpcses from a cumulative42 to 71 from mid-1986.4
Some further progress in this directionis expectedwith the new collective
wage agreement.
In financialmarkets lengtheningof nominal contracts is foun4 in
many areas. For example, there is a shift to longer term (non-indexed)time
deposits and there appears
rather
firms
than overdraft
has also
length
facilities.
increased
of nominal
contracts
The transition
small
tendency
by firms
The length
significantly.
2. Real Effects
surprisingly
a greater
of consumer
Tne general
is increasing
continuously
loans
impression
extended
is that
but at a moderate
by
the
pace.
of Disinflation
to the low Inflation
increase
plateau
51 in 1984. The fact
increase
such during
stage
In spite
of the extremely
the first
of the heterodox
has been achieved
in unemployment which reached
from 71 in 1986) compared with
successes
to use fixed-timeloans
tight
of stabilization
that
with a
62 in 1987 (dropping
unemployment
(comprising
did not
6-9 months),
monetarypolicy, constitutesone of the main
approach.
This was
- 7 -
achievedby breaking inflationaryinertia due to lagged wage indexationby
means of a wage-price freeze (thuspreventinga rise in real wages when the
exchangerate was stabilized),and by reachingan agreementwith labor for a
temporaryreduction in real wages during the first stage.
The first stage was also characterizedby a sharp reduction in the
dcmestLc
fiucal
deficit
down the financial
(which turned
markets
into
and constituted
a surplus
a first
in 1986) whLch calmed
step
in establishing
credibilityin the program.
The second stage, which coincided roughlywith 1986. was
characterizedby a sharp recoveryof domesticdemands (8.5 in real terms)
without a correspondingincreasein output (realGNP grew only by 3.32). This
was a surprisingdevelopmentin view of the eliminationof the fiscal deficit.
The consumptionboom assoclatedwith this etage and the related developments
will
be analyzed
marked real
more fully
appreciation
later.
The rise
and an increasing
which were characteristic
feitures
in demands was accompanled
import
surplus
of many unsuccessful
in constant
exchange
rate
by a
prices,
based
stabilizations.
However, this pessimisticphase reverseditself in 1987 when the
growth of domestic
adjust
demands tapered
to the new environment,
increasingby 5.2S.
The rate
off
to 5.82
responded
of real
while
output,
more vigorously
which began to
to demands with GNP
appreciationslowed down considerably
indicatinga possible convergenceto a lower real exchange rate, which may.
however,
not be sustainable
(we shall
return
The import
continued
to grow i cdollar
surplus
to this
point
later).
terms but this
reflects to a large extent the weakening of the dollar.
Measured at constant
prices the import surplus grew in 1987 at about the same rate as GNP, while
measured
moderately
in current
prices
the ratio
(from 6 to 7 percent).
of the import
surplus
to GNP rose
It is especiallynoteworthythat output of the business sector was
growing at an acceleratedrate for the past three years reachingan
exceptionallyhigh rate (7Z) in 1987. This was accompaniedby an
unprecedented
years)
growth in total
which accounted
productivity
for more than half
(compared with
the past
of the growth of output
fifteen
(table
1).
Host economiststend to attributethis remarkablegrowth performance
to the redu:uionin inflation,to the contractionof the relative size of
public sector and to the reforms undertakenin 1987. The drop in inflation
reduced producers,uncertaintywith regard to relativeprices and shifted
activitiesfrom the financialto the productivesphere. This process took
place both within firms as well as on industrylevel through a change in the
distributionof the labor-forcein favor of the non-financialsector.
The governmentcontributedto the process by freezingthe number of
employees in the public sector, so that practicallythe entire increasein the
labor-forcein 1986 and 1987 was absorbedby the business sector (see AR 87,5/
p. 73). In additionthe goveramenttook the first steps in reformiug
the structureof direct taxes which resultedin a reductionof personal income
tax rates as well as corporatetax rates 61 (for details see AR 87, chapter on
the public sector). These reformsmay have contributedto the continued rise
in productivityand to nutput growth. In addition,price stabilityand the
reduced corporatetax rate stimulatedthe upsurge of investmentin the
business sector in 1987. The latter process was further encouragedby some
initial,but important,steps in the directionof liberalizingcapital
markets.
There are
some indications
1988 as is shown by preliminary
well
as from the behavior
of a weakening
evidence
of imports
of the growth momentum in
from demand and production
and commercialbank credit.
data as
It
is
therefore
not clear as yet whether the growth performanceof 1987 was a
transitory
phase rather
that
a take
off point
for growth ln a stable
environment.
If the recessionary
indications
represent
a real
underlyingproblem
then the question is to what extent are these developmentsdue to the policies
adopted in the course of the program and in particular
rate
later
II.
policy
pursued
18 months.
in the past
on when we shall
discuss
current
We *hall
policy
dilemas.
that
brought
to the fixed
return
exchange
to these
issues
The Change of Regimes
The InflationarZ
In order
to analyze
Regime
the factors
about
the change of
regimeswhich characterizedthe transitionto the low inflation
economy we
must review briefly the forces behind the inflationaryprocess prior to 1985.
This process was associatedwith two basic interrelatedmechanisms.
One of these was related to the balance of payments crises of 1974,
1979, and 1983 which were partly due to externalcauses (the Yom Kippur war
and the two oil crises) and partly to faulty exchangerate poiicies (the
attempt to reduce the rate of devaluationin 1982-1983without a fiscal
adjustment). The policy reactionsto these crises entailed severe nominal
shocks which could not be confined to level-shocksto prices but were instead
transformedto lovq term increasesin the inflationlevel (on this see
Liviatan and Piterman (1986)3.
One of the channels
was related
through
to the need to reduce
which the foregoing
the real
wage in order
mechanism operated
to cope with
the
-
10
-
externalcrises in a setting of highly indexedwages. Under the circumstances
prevailingat the time the method which seemed suitableto deal with the
sitzationwas to erode the real wage by steppingup the rate of devaluation
and the rate of 'nflationof governmentcontrolledprices which acted as a
trigger for general inflation. Thsi mechanismwas especiallyevident in the
balance of paymentscrises of 1979 and 1983. We may note that under a system
of full wage indexationa given permanent reductionin the real wage requires
a permanent increasein the inflationplateau [these issues are discussedmore
fully in Liviatan (1 98 6b)J*
The main lesson from the foregoingdevelopmentswas that attemptsby
the governmentto erode the real wage by steppingup inflationled to an ever
increasinginflationaryspiral. This brought up the idea of dealingwith
inflationby means of a cooperativestrategy.
This s3lutioa
became potentiallypossiblewith the formationof the
coalition governmentin 1984 which representedboth labor and right-wing
parties. The new anti-inflationary
prlicy at the end of 1984 took the form of
a social pact (or 'packagedeal") to controlwages and prices. The policy
failed, however,because it was not part of a coordinatednominal policy and,
more importantly,it was not supportedby a sufficientfiscal adjustment [see
Liviatan (198 6b)I.
Another lesson from the foregoing inflationaryprocess is that in a
highly indexed economy one cannot deal with inflationunder stressesin the
balance of paymentsbecause the adjustmentin the real wage, which is
ordinarilyrequiredin this type of situation,invites inflationarymeasures.
A sound externalposition is thereforee prerequisitefor conductinga
disinflationprogram.
-
11
-
So much for the mechanism associatedwith handling of balance of
paymentscrises in an indexed economy. The other mechaism was assoclated
with the domestic fiscal deficit. The latter deficit affectedthe
inflationaryprocess in a rather roundaboutway. In particular,the revenue
from money creationwas always rather small - around 2U of GNP. (In fact it
remainedaround thls level after stabilizationin 1986-87 (see table 3)].
The large fiscal deficitswere finance insteadby indexed government
debt which the public acceptedwillingly (much of this can be explained,
presumably,by Richardianequivalanceconsiderations). Thus, till the early
1980's the fiscal deficit did not exert a direct inflationarypressure.
However, the growing ratio of domesticdebt to GNP approacheda level (about
1.3) beyond which it became difficult to finance the public deficlt though new
debt.
This was reflectedby the growing proportionof the deficit which had
to be financedby the sale of foreign exchange to the public in 1983 and 1984
(see table 3). The capital flight associatedwith this process led to foreign
exchangedifficultieseven when the current account improvedin 1984. This
state of affairs led to expectationsof a further steppingup of tho
rate of devaluationwhich intensifiedthe pessimisticview about the ability
to control inflation. As a result of these developmentsit became clear that
any disinflationaryprogram must stop completelythe growth of the public
debt, which implles a balanced budget. Only in this way could the government
restore confidencein its ability to service the debt and avoid a foreign
exchange crisis.
- 12
-
2. The Change in the Rules of the Game
In the new regime which followedthe July 1985 heterodox shock the
governmentabandoned the policy of using devaluationsin a one-sidedmanner in
order to regulatereal wages. Instead the governmentestablishedwhat appears
to be a fixed exchange rate policy over long steps which implicitlyenables
carryingout maxi-devaluationwithin the frameworkof a social contract.
The first devaluationin this regime was the initial one of July
1985. The cost push effects of this devaluationwere sterilizedby means of
an agreement (followingheavy governmentpressure) to suspend the COLA system
for three
agreed
months,
in the framework of a wage-price
temporary
reduction
in real
freeze,
wages (as mentioned
accompanied
by an
earlier).
The only formal devaluationinitiatedby the governmentin the posts
stabilizationera was in January 1987. The purpose of the devaluationwas to
correct the excessive increasein real
wages in the course of 1986. However,
unlike the one sided policies in the pre-stabilization
period it was carried
out this time in cooperationwith the General Organizationof Labor (the
Histadrut)
and the organization
of employers.
In this "packagedeal the workers agreed to give up half of the COLA
payment due in March 71 and the government
contributions
the cost
direct
to the national
effect
cost
insurance
of the devaluatlon
effects
were supposed
reduced
the employer's
by a similar
through
amount.
the COLAsystem.
to be absorbed
This sterilized
The remaining
by the employers.
The use of the foregoingstrategy,which was facilitatedby the
fiscal surplus,prevented the creationof a possiblewage-price spiral so that
the low inflationplateauwas not disturbed. [see table 13].
We may infer from this experimentthat the governmentis most
reluctant
to carry
out one sided
devaluations.
If this type of policy
can be
- 13
-
repeated in the future then Israel seems to have solved the extremely
dlfficultproblem of adjustingthe real wage by a nominal devaluationin a
highly indexed settingwithout raising the inflationplateau. It is doubtful,
however,whether the same method can be implementedon a long &irm basis under
changingpolitical conditions. This is a questionwhich one cannot answer at
the present stage.
The Focus on the ExternalPosition
The foregoing
policy
change of regime which required
could not have taken
place without
relying
a stable
exchange
rate
on a sound external
position. With a continuingpressureon the exchange rate, or with strong
waves, such a policy would not be credible
speculative
been possible
and it would not have
to secure the workers, cooperationin maintaining
stability.
It
is thereforeimportantto focus the analysison the external position.
Indeed we can see in table 1 that all the conventionalindicatorsof
the externalposition show a dramaticimprovementwith the stabilizationin
1985. The chronic current account deficit was reversed to a large surplus in
1985 and 1986 and remained
approximately
balanced
in 1987. The import
surplus,as percent of GNP, declined (table 2). Foreign exchange reserves
increasedand the net externaldebt was stabilizedin dollar terms and
declineias percent of GNP. Thus, it appears that the requirementthat
nominal stabilizationshould rely on a sound externalpositionwas fulfilled.
Since the transformationin the externalposition is consideredto be
such a crucial aspect of stabilizationwe have to investigatethe internaland
external developmentswhich brought about the change. We shall try
distinguishbetween temporary and permanent
aspects
to
of the changes which have
taken place and differentLatebetween substantiveaspects and appearances.
- 14 -
The factorswhich affect the externalposition include exchange rate
policy, foreign aid, fiscal and monetary policiesand various exogenous
developmentssuch as changes in terms of trade. These factorsmay influence
domestic absorptionand thereforethe import surplus. In addition foreign aid
influencesunilateraltransferswhich are part of the the current account.
The foreign exchangereservesare potentiallyaffected,among other things,by
exchange rate stabilization,foreignaid and various expectational
considerations(not unrelatedto the aforementionedset of factors).
4. The Effect of Stabilizinsthe Exchange Rate on Reserves
Any policy which reduces inflationdrasticallyby pegging the
exchange rate tends to influencethe foreignexchange reservesof the central
bank because of the increaseddemand for money which induces capital inflows.
However, in the case of Israel this mechanismwas of minor significance
because the central bank enabled the public to convert its dollar linked
deposits into domesticmoney at a fixed rate of exchange.
Table 3 shows that the big initial shift in portfolio in favor of
domesticmoney in the second half of 1985, amounting to 112 of GNP, took place
without changing the base of M3 ,8 / implyingthat the entire portfolio
shift was accomplishedby an exchangeof domesticassets only. This suggests
that the change
asset
in reservescannot be explainedsimply by the change in the
portfolio as a result of disinflation. The causality runs in the other
direction - it
is the Improvementin reserveswhich facilitateddisinflation.
The stabilization
effects on the
it
is considered
real
variables
of the exchange
rate
may also
have important
(consumptionand investment)to the extent that
to be temporary.
We shall
return
to this
aspect
later.
- 15
-
5. The Role of U.S. Aid
One of the factorswhich helped to bolster he foreign exchange
reservesof the Bank of Israel was the specialU.S. grant of 1.5 billion
dollars (dividedinto two equal installmentsin 1985 and 1986). This may
account for most the increasein reservesover the stabilizatlonperiod (see
table 1) if we take into account that the additlonalincreasein 1987 was due
to the developmentsfollowingthe devaluationof January of that year.
It is conceivablethat reserveswould not have increasedand that the
grant would be spent, say, on consumption. However,because of the temporary
nature of the grant we expect it to be added to savings
without affectingthe
flow of total consumption (Privateplus government)in the economy, as
permanent income theory would predict. This aspect is one of the reasons for
the bulge in the current acco;mt in 1985 and 1986.
In spite of the foregoingconsiderationthe reservesmay not have
increasedbecause of capital flight resultingfrom lack of confidencein the
program. However, the very boost to reservesmade the program more credible.
Thus, the special grant performed the role of a financial*safetynet which
did not have to be used in practice. Clearly,the special grant does not
representany fundamentalcharge but it proved to be very effective in
provLding the requiredconfidencefor the exchange rate policy.
It is also importantto note that the special grant was conditional
on Israel's implementationof a seriousprogram which had to involvemeasures
which could potentiallystop inflation. It is because of this nature of the
grant that it might have tipped the scales in favor of a drastic program.
Thus, the significanceof the special grant goes far beyond its dollar value.
-
16 -
Another factor which affected the current accountwas the change in
U. S. policy with respect to the form of financingits military aid to Israel,
whereby long term loans at an annual rate of 0.9 billion dollars (close to 4
9 / Unlike the special grant, this
of GNP in 1985 were replacedby grants.
representeda change of a permanentnature which stopped the growth of the
public debt to the U.S. governmentwhich constitutedthe major componentof
Israel's foreign debt. The U.S. decided on this move at the end of 1984 and
it was impltented independentlyof the stabilizationprogram.
Taken by itself this factor can account for two thirds of the
improvementin the current account GNP ratio between 1981 - 1984 and 1987,
which amounted to 6 percentagepoints of GNP (see table 2). One obtains the
same proportionsby computing the improvementin terms of current dollars. It
is thereforeimportantto look more thoroughlyinto the significanceof this
change, especiallyfrom the longer run perspective. As we shall see there are
strong reasons to believe that the importanceof this factor has been
exaggerated.
It may be noted that Israel'sdebt to the U.S. governmentcannot be
regardedas an ordinarycommercialdebt. In fact, it has been argued that the
U. S. civilian (non-defense)grant was used de facto to finance the debt
service. Indeed, the data in table 4 show that the civilian grant adjusted
over the years to the increaseddebt service leavinga small surplus of
100-200 million dollars annually.
In view of this considerationit is useful to look simply at the net
financial resourcetransferthrough U.S. aid (grantsplus debt serviceminus
new loans). Alternatively,one may look at the net resourcetransferminus
direct defense imports (consideringthese as tied). Table 5 shows that there
has not been any drastic change in these flows in the post-stabilization
period (the improvementcan amount to at most lZ of GNP).
- 17
-
The foregoingconsiderationsmay suggest that the relevant indicator
to look at for the purpose of the issue in question is not the current account
but rather the, basic account,which is the sum of the former and long term
capital imports (this correspondsto a 'balanceof payments,,which includes
short term capital flows and the change in central bank's reserves). Measured
in current dollars the
basic account'. showa an improvementin 1987 as
comparedvith 1981-1984of about 200 million dollars,which can be contrasted
with an improvementof about 1.2 billion dollars in the current account.
Thus, from the point of view of the basic account there has not occurredany
fundamentalchange in the externalposition.
Indeed, if it is true that the improvementin the current account is
due mainly to the switch to grants then it is an indirectpiece of evidence
that this change did not increasethe economy'spermanentincome. Otherwise
the change would increasetotal (privateplus public) consumptionso as to
offset most of the effect of the increasedgrants on the current account.
The foregoingdiscussionis not meant to claim that the switch to
grants was not significantat all. Surely it reduced
the uncertainty
concerning
policy
debt
the continuation
of the U.S. accommodative
to the growing
service and presumablyhad a favorableeffect on the attitudeof the
financialmarkets to Israel'sborrowingpossibilities.
The foregoinganalysisseems to suggest that the switch to grants had
a greater effect on Israel's liquidityposition than on its permanent income
(assummdngthat the increaseddebt servicewas to be financedby additional
grants).
Indeed, if we look at the basic account in table 1 we see that
Israel was not in any fundamentaldifficultiesin its balance of payments
before the stabillzation. It seems that it was mainly the cyclic
deterLorationsin the balance of payments, and the policy reactionto them,
that led to the accelerationof inflation.
-
6.
18 -
Real Aspects of Fiscal Policy
The basic facts concerningthe cut in the domesticfiscal deficit
are summarizedin table 6. Comparing the stabilizationperiod 1985-198710/
with the pre-stabilizat_on
period 1980-1984we find that the fiscal deficit of
the public sector (in the operationalsense) was cut by 8.6Z of GNP about half
of which are net taxes and the rest is public consumption (publicsector
investmentvaried very little). Comparing 1987 with 1980-1984,we still find
that the cut in the fiscal deficit, 112 of GNP, is again divided roughly in
11 /
half between net taxes and public consumption.
In spite of the sharp decreasein d1sposableincome in 1985,
followingthe tax hike, and regardlessof the fact that disposableincome
regained its 1984 level only in 1987, private consumptiondid not respond to
this situation,but rather started an upward surge which took an extreme form
of a 14? rise in 1986 and 7? in 1987.
The questionwhich arises in view of these developmentsare the
following:Why did not consumptionrespond to the increasein taxation? Why
did it in fact rise remarkablywhen real disposableincome remained depressed
for three years? Is there any connectionbetween the increasein private
consumptionand the reductionin public consumption?
It is quite clear that private consumptionneed not respond to the
drop in disposableincome in 1985 (see table 1) because this shock effect may
have been consideredas temporary. This is understandablein view of the fact
that most variationsof net taxes in Israel were of a temporarynature, being
related to electioncycles (as in 1981 and 1984), to unexpectedjumps in
inflation which eroded temporarilythe tax base as a result of the Tanzi
effect (as in 1984), and so on. The reactionof the private sector to these
-
19
-
variationshas been by an large in line with the permanent income theory, or
with the Richardianequivalenceapproac.. Figure 2 shows quite clearly the
remarkablenegativecorrelationbetween public and private saving over the
past 15 years.
However,while this type of reactlonmay explain lack of responseto
the initial shock it cannot explain the increasein consumption,relativeto
GNP (table 10) when disposableincome continued to be depressed. In the
followingdiscussionI wish to explore several theorieswhich might explain
the apparentcontradictionbetween the private consumptlonboom and the
contractionaryfiscal policy.
a. One interpretationcenters on the assumptionthat people perceive
the exchange rate stabilizationas being temporary,i.e. as a period of low
inflatLonto be followedby a resumptionof inflation. Suppose that ln this
setting,modelled by Calvo (1987),consumptionof liquidityservicesand
ordinary consumptionare complements (this is also consideredby Obstfeld
(1985). Then ordinary consumptionwill rise in the stabilizationperiod when
consumptlonof liquidityservicesis cheap. This factor operates regardless
of the time path of fiscal deficits.
Another feature of the (presumed)temporarinessof stabilizationis
related to the tendencyto increasethe purchaseof durables,as has been
noted by Dornbusch (1985). Indeed one observesa large increasein purchase
of durables in 1986 (table 9). However one should note that thls followedtwo
years of a low level of purchases followingan earlier boom. One should also
note that non-durableconsumption (which constitutets
about 902 of total
consumption)rose by 102 in 1986 and by 72 in 1987, which shows that the
consumptionboom is not confinedto durables.
- 20 -
In the Calvo model the stabilizationof the ezchange rate should a1so
raise the trade deficit,which was not the case in Israel (table 10). This is
explained,in part, by the reductionin public consumptionwhich matched the
increasein private consumption(comparing1981-94with 1987, Table 10). Thus
fiscal policy with respect to public consumptionoffset the expansionary
effect generatedby the (presumably)temporaryexchange rate stabilization.
b. An alternativeinterpretation,
which is referredto briefly in
AR87 chapter 2, takes an oppositeview of expectations. Thus suppose that
people really believe that stabilizationis here to stay and they also believe
in the permanenceof the cut in public consumption. Assume further that
people use public consumptionas an indicatorof their permanent level of net
taxes.1 2/
This can be justifiedon the basis of the greater stabilityof
public consumptionrelativeto nut taxes (see table 7).
Now it may be assumed that people expectedthe stabilizationto be
based on the eliminationof the fiscal deficit. On the basis of past
experience
achieved
they may have thought
by a rise
in net taxes.
that
the balancing
of the budget
will
be
In practice,however,half of the cut in the
fiscal deficit was in the form of a reductionin public consumption. Since
the latter is an estimateof permanentnet taxes people found themselveswith
higher permanent disposableincome which induced them to increasetheir
consumption,in spite of the fact that their measured disposableincome went
down. To put it differently,permanent disposableincome went up because the
increase in taxes was less than expected. It should be noted thr.tthis theory
explainsnot only the emergencyof the consumptionboom but also its
magnitude,
which should
be roughly
equal
to the decline
in public
consumption.
- 21 -
According to this interpretationthe reductionin public consumption
appears to be the cause of the consumptionboom so that on the whole fiscal
policy was neutral with respect to the import surplus.
What was then, in retrospectthe benefit of cutting the fiscal
deficit through public consumptioninsteadof making the full adjustment
through taxation? One of the advantagesin making the adjustmentthrough
public consumptionis that in a world of uncertaintythe latter form is a more
credibleway of convincingthe public of the permanenceof the fiscal
adjustment,which has favorableeffects on the financialposition of the
economy.
Secondly, unlike the model of Ricardianequivalence,taxes are
distortionary. This is especiallythe case in Israel whose gross tax rate is
among the highest in the world. Raising taxes still more is most undesirable.
Thirdly,the cut in the relativesize of the public sector made it possibleto
divert the entire incrementto the labor force to the (nonfinancial)business
sector, thus contributingto a more desirableform of growth.
c. An additionalinterpretationcan be given on the basis of the
distributionalaspect of stabilization. AR 87 points out that the
stabilizationprogram brought about a sharp increasein net (disposable)wage
rates
in 1986-87. This was so because the gross real wage rate increased
sharply in these years (especiallyin 1986) while the rates of direct taxation
on labor income actually fell [thiswas offset by a sharp increase in the
taxationof non-wage incomes in 1986. (See AR87 ch. 5)]. The dominant factor
mas however,by far, the increasein gross wages.
Table 8 shows that the decline in the net wage rate (per employee
post) was mild in 1985 and the increasewas sharp in 1986 comparedwith total
disposableincome (table 1). Assuming that the marginal propensity
- 22
-
to consume out of wage income is higher we obtain a possible explanationof
the consumptionboom. Iu fact table 8 shows that net wages and consumption
were quite closely correlatedin the 1980's. 13/
According to this interpretationthe change in the income
distributionin favor of labor outweighedthe effect of a reductionin total
disposableincome as far as private consumptionis concerned. However,was
the increase in gross wages (whlich
wac the dominant featuresof this process)
an independentfactor or was it due to demand pressures generatedby the
exchangerate stabilization? The answer to this questionis not quite clear
(we shall return to this issue later).
d. It has been pointed out that the greater sense of securitywhich
came with stabilizationtended to increaseprivate consumption. But, as is
well known, the effect of uncertainty (as is the effect of the interestrate)
on consumptionis ambiguous.
I would suggest that the differentinterpretationsgiven above should
not be consideredas mutually exclusive. Thus it might well be the case that
in the early phase of stabilizationthe public was much more skepticaland
behaved accordingto the Calvo model and then, as the program gained more
credibility,the more optimisticinterpretationtook over. To the extent that
wage pushes were importantthey can be added to the other interpretations.
7.
FinancialAspects of the Fiscal Adjustment
The foregoingdiscussionsuggestedthe possibilitythat the fiscal
adjustmentdid not have an appreciableeffect on Lotal domesticdemand and
consequentlydid not affect the import surplus. However, the eliminationof
the domestic fiscal deficit had a most sinpificant
effect
on the financial
markets by restoringthe confidencein the government'sability to service the
_ 23 -
debt. This renewed confidencereduced the threat to the reservesof the
central bank and provideda firm supportfor the fixed exchangerate policy.
One indicatorof this transformationis in the compositionof deficit
finance (see table 3). Prior to stabilizationthe proportionof foreign
exchange sales increasedrapidly till it reached 8.62 of GNP in 1984 (this
accountedfor two thirds of the deficit comparedwith one quarter in 1982)
However, after stabilizationthese net sales fell gradually to zero.
Another indicatoris the behaviorof the derived capital import of
the private sector,which measures the excess of the current account over the
sales of foreign exchangeto the private sector. This measure indicatesthat
the capital exports,^.ich characterized1984 and the first half of 1985
turned into capital imports from the second half of 1985 (see table 12).
Similarly werrorsand missions" of the private sector indicatean
intensificationof capital flight in 1983 through the first half of 1985, a
process which stopped abruptlyin the second half of 1985 and did not reappear
since.
The foregoingdiscussionsuggeststhat the main role of the fiscal
adjustmentwas in its effect on the financialmarkets rather than on the trade
account.
8. Domestic Investmentand MonetaryPolicy
The offsettingeffects of private and governmentconsumptionimply
that national saving out of GNP was not affected in any significantmanner by
the stabilizationprogram. This means that the improvementin the trade
accountwas related almost entirelyto the reductionin the investmentIGNP
ratio. One can see in table 10 that the improvemcntin the trade account/GNP
ratio matches the reductionin the investment/GNP ratio.
- 24
-
The fall in investmentcannot be consideredas an autonomous
development. The decline in investmentin ,ixed assets began in 1984 and it
was part of a policy of improvingthe trade balance in the wake of the crisis
which followedthe abandonmentof the policy of slowing down the rate of
devaluationin 1983. This was accomplishedby tighteningmonetary policy
which led to an increasein the real interestrate (see table 1) and to an
improvementin the trade account.
The tightermonetary policy followingthe initiationof the
stabilizationprogram in 1985 raised short-terminterestrates on free credit
to the domesticmarket even more. This policy discriminatedagainst finance
of domesticactivitysince interestrates on loans to exporterswere not
affectedappreciably. In particular,this policy hit hard construction
activitywhere the interestcomponent in costs is relativelyhigher. Thus in
1985 and 1986 investmentin residentialconstructiondropped 12 and 8 percent
respectivelyin real terms (AR87,p. 31). Since constructionaccounts for
more than 40Z of total gross investmentwe may infer that tight monetary
policy played a significantrole in cutting investment.
In 1987 there was a recoveryof domesticinvestmentfollowingthe
surge in economicactivitybut the level still remainedbelow normal. Real
interestrates on credit lines to the domesticmarket still remainedvery high
(about 2.5Z per month). Although these high rates on loans,which exceed by
far the deposit rates, are consideredexcessiveby the Bank of Israel, yet the
fact remains that they hamper constructionactivitiesand perhaps other forms
of investmentas well.
Since the ratio of capital to output has been fallingin the past
three years and since real interestrates are expectedto fall in the future
one may expect a recoveryof investmentin the years ahead with a possible
- 25 -
negativeeffect on the trade balance. However,with improvedconfidencein
the economy this need not create difficultiessince higher investmentwill
contributeeventuallyto future output and exports.
9. SummingUp the Influenceson the Exte)nalPosition
Table 10 sums up the changes in the import-surplus,following
stabilization,in terms of domesticuses. When we compare 1987 with the
1981-1984average,in terms of current ratios to GNP, we find that private and
public consumptionroughlyoffset each other, with the changes being in the
order of 5.5t of GNP. This means that the improvementin the trade account by
about 3.5Z of GNP is "explained*mainly by the cut in investment.
The foregoingcomparisonswhich are based on ratios of various
variablesto GNP, measured in current prices,may be problematicwhen the
exchange rate is consideredas overvalued(as might be the case in 1987 as a
result of the fixed exchange rate policy). In this case the import surplus
will be downwardbiased. In order to check this point we carried out the same
comparisonsusing constantprice variablesas computedby the Central Bureau
in table 11. They show essentially
of Statistics. The results are suzmmarized
the same picture as the current price ratios and thereforedo not require
additionalcomment.
Accordingto one of the earlier interpretationthe reductionin
public consumptiongeneratedan increasein private consumptionwhich offset
the effect of the former on the trade account. The improvementin the trade
account is then attributablemainly to the tight monetarypolicy which brought
about a reductionin the investment/GNPratio. Thereforethis improvement
cannot be consideredas being due to fundamentalchanges.
- 26
-
Indeed, the most significantchange in the externalpositionwas of
financialrather than of a *real"nature (meaningthe trade account and
relatedmeasures). This was the eliminationof the constant injectionof
liquiditythrough the large fiscal deficitswhich threatenedto lead to
recurrentfinancialcrises, especiallyin the foreignexchangemarkets.
If the changes in the current accountwere not fundamental,does it
mean that the present state of affairs is not sustainable? Not necessarily.
First, as we noted earlier, it is not quite clear that the state of the
balance of payments in the pre-stabilization
era was not sustainable.
Secondly,even if a fundamentalimprovementwas indeed requiredit may still
take place in the future with the stimulusof growth provided by a stabilized
economy and by the benefits of reforms in the tax structureand in the capital
markets.
III. Evolutionof Policiesin the Course of Stabilization14/
1. Fiscal Policy
Since the beginning of the stabilizationprogram till the end of 1987
the governmentmaintainedconsistentlya virtuallybalance budget with
domesticdeficit runningat about 1Z of GNP. The persistentbehaviorwas
maintainedboth with respect to direct domesticpublic sector demands and net
taxes. However since the last quarter of 1987 through the second quarter of
1988 there are indicationsthat the public sector deficit is increasing. This
is based on estimatesof the central government'sdomesticdeficit,calculated
on a cash basis from the Bank of Israel accounts. According to these
estimatesthe domestic deficit in the last three quarters (includingreal
interestpayment on the public debt) was around 4Z of GNP. While this
- 27
-
reflects, probably, the temporary stresses due to the oncoming elections it
may exert a destabilizing influence on the delicate balance achieved by the
program.
We have mentioned earlier that in 1987 there was a change in taxation
policy with the introduction of the reform in direct taxes (see footnote 6).
Taken by itself this would have reduced the government revenues by 3S of GNP
(AR87 estimate). However. the increased efficiency in tax collection due to
the low inflation (the Tanzi effect in reverse) offset the foregoing tendency
so that the share of net taxation in GNP remained unchanged.
2.
Monetary Policy
The spite of the fixed exchange rate regime the government used
monetary policy in an active manner throughout the program. This was made
possible by the tight controls on capital flows. At the beginning, monetary
policy contained domestic activity and discouraged capital flight through very
high real interest rates for loans to the domestic market (even if we assume
high values for inflationary expectations). Figure 3 shows the significant
spread between domestic and foreign interest rates (adjusted for devaluation)
which existed since nominal interest rates stabilized in the first half of
1986.
It can be seen that this spread remained constant even when the black
market premium fell significantly.
One of the manifestations of the central bank's active stance was the
tight monetary policy implemented in the beginning of 1987 in order to prevent
an acceleration of inflation following the January devaluattLA. This exercise
raised domestic interest rates (figure 3) and induced large capital inflows,
in spite of controls, which reversed themselves later in the year when
expectations of devaluation were revived. Thus although capital flows limited
the possibility of conducting monetary policy, yet the controls on these flows
left enough room to use the policy quite effectively.
-
2b -
In the course of the program there was a shift from using commercial
bank credit as an intermediatetarget to a wider concept - net domesticcredit
(NDC). This shift seems justified in a fixed exchange rate regime where the
focus is on foreign exchange reserves. With NDC being defined so as to
satisfy the equation:
Honey- NDC
+
reserves
one may regard the targetirgof NDC, given Money', as targetingreserves.
The concept of money chosen for this purpose is M3 which includesH2
plus deposits linked to foreign exchange (PATAM),15/ the reason being that
the demand for M3 is more stable than for M1 or M2 (see table 2). As a result
of this targeting real bank credit was allowed to grow 16/ fast while
real M3 growth was restricted. In fact M3
relativeto nominal GNP declined
slightlybetween 1986 and 1987 (see table 2). While this policy indicatesan
effort to keep reserves from falling it does representat the same time an
accommodatingmonetary policy towards inflationwhich continuedat a rate of
202 per annum. We may infer thereforethat the basic nominal anchor was the
exchangerate; monetary policy provided indirectsupport for this anchor by
guardingforeign exchangereservesbut not directlyby settingnominal targets
of NDC or for money.
2. Exchan8eRate Polic,
In the first stage of stabilizationthe exchangerate was pegged to
the U.S. dollar
in an act which symbolizedthe new era of stability. Once the
weakening of the dollar became an anticipatedphenomenonthis policy was
Implicitlyone of planned devaluationat a slow rate, which amounted to a
devaluationof 162 with respect to the basket of currenciesin the first year
of the program. 17,
-
29
-
Since August 1986 the exchangerate was pegged to the basket of
currenciesand since then it was devaluedby 1O in January 1987 and by about
3.5Z till the first quarter of 1988. On the whole, since the third quarter of
1985 till the first quarter of 1988 the exchangerate of the basket was
devaluedby 352 while the consumersprice index rose by 56Z. Since it is
unlikely that this differencewill be allowed to widen or even to persist one
may infer that the emergingexchangerate policy is one of long steps (many
people expect the next devaluationwithin the frameworkof some agreementto
sterilize,at least partially,its effect in the cola.
The authoritiesclearly rejectedthe policy of a crawlingpeg based
on mini-devaluations.This is motivatedby the objectionto legitimizethe
crawling inflationand also by the desire not to commit oneself to any rate of
inflationbefore the post-stabilizatIon
conditionsbecome clearer. A floating
exchange
still
rate is unthinkablein the present situationbecause the economy is
highly
secondly
indexed
because
understanding
and therefore
under
with
the latter
labor
very
regime
susceptible
to nJminal
shocks
and
it is more difficult to reach an
about wage policy.
IV. Policy Dilemmas
1.
The Low Inflation
In the early
to 1 5-2 percent
stages
annually
of the stabilization
per month it was thought
However, as time passed
became clearer
Step
that
(see table
and inflation
that
program,
this
is a temporary
showed no sign of falling
economy is on some low inflation
13).
when inflationfell
What could be the reason
step
phase.
further
it
of about 20S
for having
an inflation
in
excess of the industrializedcountrieswhen the budget was balancedand the
central bank had ample reserves?
-30-
The theory of inertia due to staggeredprices does not seem to be an
appropriateexpianationsince in this case we should observe a declining trend
for inflation. Similarly,the wage price spiral due to lagged indexation
adjustmentwas neutralizedby the controlsand the package deal at the
beginning
of the progeam.
One of the explanations
rate
policy
exchange
followed
rate
for this
phenomenon was the exchange
in the first year. As noted earlier,by pegging the
to the dollar
shekeldepreciated
offered
relative
when the latter
to the basket
was weakening,
of currencies
the
by 162 in the first
year. 17/ This may have out the economy into an expectationalorbit of about
202 inflation.
Why did the authoritiesnot peg the shekel to the basket of
currenciesLuediately when it became known that the dollar was likely to
continue
weakening?
It is argued
that maintaininga fixed exchange rate with
respect to the basket would imply an absolute reductionin the exchange rate
of the dollar. This would requirean absolute reductionin the prices of
exports to the dollar
area.
If wages and prices of inputs exhibit downward
rigidity then this may entail unemployment(See Bruno and Piterman (1987)).
However, this argument still does not explainwhy prices, in a poststabilizationenvironment,should exhibit greater rigiditythan in the
industrializedcountries,which somehow overcamethese difficulties.
An alternativeexplanationfor the low inflationstep is that people
do not expect the governmentto fight in order to reduce furtherwhat appears
to be a low Inflation
from a high level
level
after
to the present
the big achievementof reducing inflation
one. Thereforethey expect the governmentto
accommodate wage and price Increases
cannot explain
which do not exceed
critical
level.
why the critical level is around 202 per year but one may
One
- 31 -
mention that a low inflationstep of this order of magnitude has been observed
in other successfulstabilizationsin chronic inflationcountries (as was the
case followingthe 1964 stabilizationin Brazil, or in Chile in the 1980's).
In supportof this argumentwe may note that the only method which
seems to have worked so far in reducinginflationin a susta'nablemanner was
neither monetary nor exchange rate policy but rather the heterodox shock of
July 1985. However,one cannot expect realisticallythat the governmentcan
mobilize the politicalpower to repeat the same steps to subdue a low
inflation,which by itself is consideredas a big victory. Moreover, the very
fact that the governmentused controls and package deals to avoid unemployment
when it reduced inflationunderminedits credibilityto accept a recessionas
part of its disinflationaryeffort, which reducesthe effectivenessof
monetary policy. In view of these considerationsthe public expects the
governmentto accommodatemoderatewage and price increases,which puts the
goverment in a difficult dilemma.
The danger in accomuodatingthe low inflationstep is that the
process of maintainingdomesticinflationabove the world level for a long
time to likely to be unstable. It is difficult to reduce the degree of wage
indexationwhen it is known that the economy faces recurrentjumps in the
exchange rate (with uncertaintiming). So the system remains susceptibleto
other
big nominal
low inflation
period
therefore
step.
shocks which are bound to come sooner
On the other
hand,
a non-accomodative
of unemployment which is not acceptable
that
the dilemma of the low inflation
politically.
step
or later
policy
and rock the
may imply a
It seems
is some form of the olf
trade-offbetween inflationand unemployment. In orthodox stabilitation
(using a monetary crunch) this issue appears immediatelywhile in a heterodox
stabilizationit emerges at a later stage.
-
32 -
2. The Issue of Real ADpreciation
One of the disturbingfeaturesof the stabilizationprogram is the
continuingreal appreciation,amountingto 15? between 1985 and 1987 (see
table 1). This is generallya featureof exchangerate based stabilizations
which are heading towards a crash. However,ordinarilythe real appreciation
is associatedwith a sharp rise in the import surpluswhich is not quite the
case in Israel.
In the course of the stabilizationprogram the import surplus as
percent of GNP (in current prices) rose by 1.5 percentagepoints in 1986 and
by 12 in 1987). This does indicatea worseningof the import surplus but not
at an alarming rate. We also recall that the level of the import surplus in
1987 was still far below the pre-stabilization
period.
We may look alternativelyat a comparisonbased on quantitymeasurep
of domesticuses and of GNP (the indifferencebetween these being the import
1
surplus). These indicatorsshow that while in 1986 the growth of domestic
uses exceeded GNP by 5, the excess dropped to 0.52 in 1987. This difference
and some additionalconsiderationssuggest that we should deal separatelywith
1986 and 1987 (extendinginto 1988).
One of the accepted interpretationsof the fast rate of real
appreciationin 1986 is the foregoinggrowth in domesticdemandswhich
presumablyoriginatedfrom the greater sense of securitywhich followedthe
success of the program in its initialphase. (An alternativeinterpretation
could be providedby the Obstfeld-Calvoapproach). This is the demand pull
interpretationof the real appreciationin 1986.
- 33 -
It has been pointed out, however,that the increasein demands in
1986 followeda year of most depresseddomesticdemand (see table 10).
Comparing the quantitylevels of domesticuses (relativeto GNP) in 1986 with
earlieryears we find that the level of domesticdemands in the latter year
was about the same as in 1984 and much lover than in 1983 while relative
prices of exports and importswere much lower in 1986. These facts suggest
that the real appreciationin 1986 may be due to cost pushes from the labor
1 8/ This view is supportedby
market after the relaxationof wage controls.
the sharp rise ln labor costs in 1986 and by the fact that unemploymentwas
higher than in 1983 and 1984 (see table 1).
The demand-sideview of the real appreciationin 1986 does not
explain much about the continuedreal appreciationin 1987 because the growth
1* latter year was balanced. 19, The wage push theory is also problematic
because lt does not seem to be consistentwith the remarkablegrowth of output
in the business sector and the drop in unemployment. The upshot of the
discussion
foregoing
real
exchange
rates
of the balance
is that
it is difficultto explain the behavlorof the
or the real
period by means
wage in the post-stabilization
between domesticuses and GNP. Explanationsbased on cost push
considerationsare not particularlyillui-nAtingeither in vlew of the
acceleratedgrowth in 1987.
An alternativeapproachto the issue of real appreciationcould be
based on the idea that stabilizationhas brought about a structuralchange in
the
financialand productivesphereswhich changed the equilibriumreal
exchange rate. For example, the improvedliquiditypositionof the economy
may have reduced
sector.
precautionary
demand for
foreign
exchange
by the private
Given the restrictionson capital flows this may have cause a real
appreciation.
A similar
conclusion
can Le obtained
if the reduction
in
-
34
-
uncertaintyhad a relativelylarger impact on productivityin the sector of
tradeables. The reductionin government'sdomesticpurchases of tradeables
may have worked in the same direction. However, the verificationof these
hypothesesrequiresdetailedresearch.
If the real appreciationwas in fact due to structuralchanges then
it need not be a cause of concern. There are however reasons to believe that.
part of the real appreciationcan be attributedto unduly strong attachmentto
the fixed exchangerate policy in face of inflationaryexpectationsof the
type describedin the proceedingsection.
In order to clarify this point we may suppose that in the course of
1986, and especiallysince the pegging of the exchange to the basket of
currenciesin August, people were expectinga correctivedevaluationat some
uncertain (but not very distant)date.2 0 /
The actual devaluation(of 1OZ)
took place in January 1987. Therefore the expectedlabor costs in 1986 were
lower (especiallyin the second half) than the observedones and the opposite
is trust of the real exchangerate. Thereforethe data exaggeratethe real
appreciationin 1986. The correctionin real wages and relativeprices
brought about by the devaluationcan be seen in table 14.
The same considerationcontinued to work even more forciblyin 1987
because then the exchange rate was practicallyfixed with respect to the
currencybasket while domesticinflationcontinuedunabated. This led to a
rise in real wages and drop in relativeprices of exports and importsduring
the year
till
following
the devaluation
in the beginningof 1988 nor after that
this day (July 1988).
According to this view there is really no contradictionbetween the
balance growth in 1987 the real appreciationbecause the expected real
exchange rate may have remainedconstant. Indeed,as figure 1 shows, the
- 35 -
black dollar premium rose continuouslyafter the devaluationin the beginning
of the year till many people began to believe that devaluationwill be
postponed (perhapstill after the Novemberelections).
While in the January 87 devaluationthe workers accepted a
(temporary)cut in real wages it seems that it was not possible to repeat the
same agreement in the beginningof 1988 because of the approachinggeneral
elections. Hence employers realizedthat real wages are indeed higher than
previouslyexpected and the oppositewas true for the real exchange rate.
The realizationthat real wages may stay at a high level for some time may
explain the recessionarytendenciesin the economy in the second quarter of
1988.
21,
The foregoing
,agreed
devaluations'
analysis
brings
- namely that
out a weakness
their
of the present
implementation
regime of
is restrictedby the
political conditionsregardlessof the economicnecessity. The dilsmma is
that
returningto one sides devaluationswhen the economy is still highly
indexed may bring
back the old wage-exchange
this dilemma will
be solved
disinflation.
rate
spiral.
is one of the key issues
for
The way in which
the continuation
of
- 36
-
FOOTNOTES
See Bruno (1986)and Liviatan (1986a)
2
The spread with respect to nominal (ex post) dollar linked loans for
domesticactivitywas considerablysmaller. The latter interestrate
remained about 1-1.5 percentage points above inflationin monthly terms.
Even this representsa large spread, especiallyif we take into account
that the expectednominal rate on these loans exceeded the actual one
because the same thing applies to devaluation(especiallyin 1987).
S
Interestrates on loans to exporterswere kept close to international
levels.
4
In additional,the degree (percentageof compensation)of wage
indexationwas reduced from 80Z to a range between 70-80S dependingon
the time which elapsed between consecutiveCOLA payments.
5
We shall use this notation for Bank of Israel Annual Report 1987
(Hebrew),with similarnotation for other years.
6
Within the frameworkof the tax reform the income tax rate on
undistributedcorporateprofitswas reduced from 61 to 45 percent. As
for personal income tax, the two highest steps of the tax rates - 50 and
60 percent - were abolished,with the maximum rate being reduced to 48S
(howevera temporary surchargewas imposed on the latter bracketwhich
raised it to 532 till December 1987).
7
One form of compensationfor the workers was the government'sobligation
to freeze prices of a number of 'basLcecommoditiestill April 1988.
The base of 13 consists of the money base (base of 42) plus the reserve
requirementsof the private banks (depositedin the Bank of Israel)
against foreign exchange linked depositsof the private sector. Since
the latter require a 1002 backing of reserves (again in the form of
foreign exchange linked deposits),the shift towardsnon-linkeddeposits
followingdisinflation,created excess reserveswhich were partly
sterllized
by raising reserve requirementon shekel deposits.
9
Total U.S. governmentaid to Israel in 1984 was about three billion
dollars
which consisted
of 1.8 billion
in military
aid (half of which
was a grant) and 1.2 billion
dollars
as a *civilian
(non-defense
grant).
Note that the change from loans to grants does not affect
the
net resource transfer
in the short run and therefore
should not be
reflected
in the changes in the foreign exchange reserves.
10
Strictly,
partial
11
Two other facts about the fiscal
adjustment
are worth noting.
1985-87 with 1980-84 in terms of average ratios
of GNP we find
the stabilization
fiscal
adjustment
period began in July
took place in the first
1985 but in fact a
half of this year.
Comparing
that
-
37 -
domestic defense expendituredsdedcreasedby 2.6 percentagepoints of
GNP while civilianpublic consumptionwys reducedby 1.5 percent of GNP.
Thus most of the cut in public consumptiondid not compete directlywith
private consumption. On the revenue side, net direct taxes, as S GNP,
were not affectedby stabilizationso that the entire increasein net
taxes took place in indirecttaxes.
12
Whien the government'sbudget 4s,intertemporalybalancedw tG ;tT -b
,her; G
anatTare the permanent flows (properweighted averages)of
governmentconsumptionand taxes as seen at time t,tb
is the stock of
the public debt at t and r is the interest-rate. Permanentdisposableincome is then given b tY
:tG
tY :tT + Eb where Y is permanent
national
income.
13
It should be pointed out however that the variationsin 1981 and 1983 in both
variableswere related to direct policiesof slowing down inflation.
14
On these issues in the first two years see Bruno and Piterman (1986).
15
This implies that NDC in the sum of net domesticcredit to the governmentand
to the private sector provldedby the Central Bank and the private banking
system.
16
The growth in domesticbank credit was offset by a contractionof net-domestic
credit to the government. Thus the governmentcontinuedto borrow from the
public for non-fiscalreasons (the justificationfor this policy is not clear.
17
Comparing their
18
One of the manifestations
of the wage push were the lxge
minimum wage, which continued at a slower pace in 1987.
19
In the sense that domesticuses increasedin the same proportion
constantprices).
20
It is the variation in expectationsabout the timing of devaluationwhich may
cause inexplicablemovements of the black dollar premium.
21
Part of the recessionarytendencymay perhaps be attributedto the consequences
of the political unrest In Israel'soccupied territories.
quarters
of 1986 and 1985.
increases
in the
as GDP (in
- 38
-
REFERENCES
Blejer, H. and N. Liviatan (1987), *FightingHyperinflation- stabilization
StrategiesIn Argentinaand Israel, 1985 - 1986', IMP Staff Papers, Vol. 24,
No. 3, 409-438.
Bruno, M. (1986), 'Generatinga Sharp DisinflationtIsrael 1985'. NBER,
Working Paper No. 1822.
Bruno, H. and S. Piterman (19S7), 'Two Years of the StabilizationProgram:
Israel 1985-19870,EconomicQuarterly (Hebrew),September1987.
Calvo, G.A. (1987), 'Balanceof PaymentsCrises in a Cash in Advarce Economy',
Journal of PoliticalEconomy, 94, 1319-1329.
Dornbush,K. (1985), 'InflatLon,exchange rates and stabilization",NBER
Working Paper No. 1739.
Liviatan,N. (19 8 6a), 'Inflationand Stabilizationin Israel - Conceptual
issues and Interpretationof Developments',IMP Working Ps-ner,November 1986.
Liviatan,N (19 8 6b)), 'The Evolution of DisinflationaryPoliciesin Israel',
Working Paper.
Liviatan,N. and S. Plterman (1986), 'AcceleratingInflationand Balaace of
PaymentsCrises, 1973-1984',in Ben-Porat,Y. ed., The Israeli Economy
Maturins Throush Crises, Havard UniversityPress.
Obstfeld,M. (1985), 'The Capital Flows Problem Revisited:a StylizedModel of
SouthernCone Disinflation",Review of Econnic Studies,52, 605-26.
- 39 -
Table 1
Economic Indicator1981 - 1987
1981
1982
1983
1984
1985
1986
annual change (S) in real terms
1987
1. Real disposableincome 14.2
2. Private consumption
12.0
3. Public consumption,(excl.
defense imports)
1.4
4. Gross investmentin
fixed assets
3.7
5. Gross domesticproduct
(GDP)
3.8
6. Total domesticuses
(Const.prices excl.
defense imports)
6.5
7. GDP business sector
4.7
8. Total productivity
(businesssector)
3.0
9. Real Wage rate
11.1
10. Real labor cost per
unit of output
(businesssector)
-1.6
-2.6
7.7
2.8
8.3
8.7
-6.8
-11.1
0.5
2.8
14.2
7.3
8.1
2.9
2.2
1.5
-1.0
-3.5
1.8
5.1
12.6
-11.3
-7.8
-1.6
13.7
1.0
2.6
2.4
3.7
3.3
5.2
7.2
0.0
7.0
3.1
-4.7
2.8
-2.2
5.0
8.4
5.3
5.8
6.9
-1.0
-0.9
-0.1
4.7
-0.3
-2.5
4.1
-6.8
3.0
11.6
3.4
8.2
6.8
5.4
-5.6
0.7
8.4
3.0
5.9
6.7
7.1
6.1
I. Demands,Outputs and
the Labor Markets
------------------------------------------------------
11. Unemploymentrate
5.1
5.0
4.5
$ billion, current prices
II. Balance of Payments
1. Current Account
-0.9
-2.0
-2.1
-1.1
-1.1
0.8
(0. 3)
(0.0)A
-0.3
2. Unilateraltransfer
2.9
2.6
2.9
3.4
5.1
5.4
4.8
3. Import surplus
(excl. defense)
4. Basic account
2.1
0.3
3.0
-0.8
3.8
0.3
3.3
-0.4
2.1
1.2
2.7
1.3
3.4
0.1
(0.4)A
(0.5)A
13.4
15.6
18.3
19.7
19.3
19.2
19.2
3.8
4.3
3.8
3.3
3.8
4.9
6.0
5. Net externaldebt
6. Net international
reserves
---------------------------------------------------------------------
__------__---
Index 1980 - 100
7. Relativeprice of
exports
8. Relativeprice of
imports
98
93
91
92
92
82
77
96
91
85
87
93
83
80
- 40 -
9.
1981
1982
1983
1984
1985
1986
1987
102
107
111
107
107
110
107
1.5
1.2
1.3
1.6
0.5
1.1
Terms of trade
III. Prices and Interest
Rates (X)
Monthly change (X)
6.0
6.2
7.2
7.5
9.3
9.7
15.2
15.2
9.1
8.0
5.6
6.2
9.4
15.7
8.4
1. Consumerprice index
2. Wholesale price index
3. ExchangeRate (basket
of currencies)
---------------------------------------------------------------------
4. Interestrate on loans
5. Interest rates on
deposition
__------__---
8.7
N/A
7.6
N/A
Monthly (Z)
9.0
19.8 15.3
N/A
14.5
8.4
Sources Bank of Israel Annual Reports (AR) and data base
of Research Department.
1.13 Includingtransfersfrom abroad.
1.4: For economy as a whole. Deflatedby CPI
11.1 Defense imports include always advancesfor purchases
in order to smooth these import data.
II.9: Of exports nd non defense imports (exc. capital services).
111.3: Bases on five currencies.
111.4: Overdraft facilitiesfor domesticmarket activities
(in domesticcurrency).
111.5: CD rate.
^ Excluding special US grant.
4.0
1.3
4.0
1.4
-
41
-
Table 2
EconomicIndicatorsam Z of GNP
1981
I. Fiscal
Domesticdeficit
Total deficit
Gross taxes
Not taxes
5. Net ezternal debt
6. Net domestic debt
1.
2.
3.
4.
5.
1983
1984
1985
1986
1987
7.3
7.8
46.1
26.2
42.0
120.0
16.6
19.0
38.2
18.3
50.0
128.0
7.3
2.2
451
27.7
51.0
138.0
1.4
-2.8
48.4
32.4
39.0
130.0
1.2
0.1
47.6
32.1
34.0
121.0
2.8
6.3
20.7
21.6
8.7
1.9
5.4
23.3
20.8
12.8
2.3
9.4
25.1
23.3
16.2
4.0
13.8
23.4
25.1
13.4
5.0
18.6
25.2
30.8
12.0
9.7
4.5
6.1
7.0
4.8
(1.7)
79.0
2.9
(0.4)
63.0
(public sector
1.
2.
3.
4.
11.
1982
13.2
10.2
15.4
12.1
42.6
45.5
18.5
24.5
38'.0 38.0
122.0 125.0
Monetary
Hi
M2
M3
Total bank credit
Net domesticdebt
3.9
5.7
19.0
NA
3.4
6.1
19.6
23.5
NA
TII. International
1. Import
2.
Current account
3.
Net externaldebt
9.6
10.9
12.1
-4.0
-8.3
-7.9
-6.8
62.0
65.0
76.0
Sources Bank of Israel Annual Report and data base of
Research Department
Based on real interestrates.
Domestic plus foreign
M3 - M2 plus deposits linked to foreign exchange.
Net domestic credit to private and public sectors,
defined to satisfy H3 - net domesticcredit plus
foreign exchange reserves
of the Bank of Israel.
IIIls: xzcluding defense imports.
1.1s
1.2:
11.3:
11.5:
Excluding
Z
special
US grant.
-0.8
53.0
_ 42
-
Table 3
Domestic Deficit oi Public Sector and Its Financing (Z of GNP)
1982
1983
1984
10.0
6.0
12.3
9.3
2. Change in M3 base
2.6
2a. (additionto the base
Of 13
1.7
3. Net increasein domestic
debt
5.3
4. Sale of foreigncurrency
2.6
S. Intereston monetary base -0.6
7.6
3.9
2.3
-6.3
6.3
-1.6
1. Domesticdeficit
1985
whole
2nd
year
half
1986
1987
6.0
3.9
2.7
0.9
-0.4
-0.5
1.7
3.0
6.5
10.6
1.9
2.7
0.0
8.6
-0.2
4.6
4.8
-1.1
5.3
2.2
-1.0
3.2
2.5
-1.4
3.1
-0.1
-2.0
Composiitonof
Deficit Financings
Source:AR87, p. 224
1. Includesreal interestpayment on domesticdebt.
2.
M1 - M2 plus
foreign exchange-linked deposits.
3. Includes also changes in the balance of monetary loan
to banks (treatedas a negativemonetarybase.
Table 4
Debt Service
1. Debt service to
U.S. government
2. Civilian grant
3.
(2)
(1)
Sources
(2)
and Civilian
Million $
Grant
19771981
19821984
1985
1986
1987
495
625
130
883
1,100
217
1,055
1,200
145
1,079
1,200
121
1,129
1,200
71
AR86, AR87.
Civilian
grant
1985 and 1986.
excludes
special
U.S. grant
of $750 million
in
-
-43
Table S
Not US Aid
ML11ions $
1982
1983
1984
1985
1986
1987
19811984
19851987
1,595
1,805
2,174
2,080
2,391
2,122
1,861
2,198
57
650
465
198
540
395
312
378
1981
1.
2.
Net Financial
US aid
1,871
(1) minus
dLrect defense
76
imports
Sourcet
(1)
Bank of Israel Annual Reports.
Excludes special grant of 1985 and 1986. Referred to in text as 'net Financial
resource transfer* (grants plus debt service minus new loans).
Table 6
Public Sector Consumption, Investment, and Net Ta"es,
(Z) of GNP
Public consumption
(domestic)
Public investment
met taxes
Domestic deficit
Sources
(1)
19801984
(2)
19851987
32.2
3.2
23.5
12.0
28.2
3.1
27.9
3.4
(3)
(2) - (1)
-4.1
-0.1
4.4
-8.6
(4)
27.4
3.5
29.7
1.2
-4.9
0.3
6.2
-10.9
AR87, p. 90.
Hot tazes
Public consumption
(diostic)
Sources
(4) - (1)
1987
Table 7
Net Taxes and Public Consumption. 1981
(1) of GNP
1.
2.
(5)
AR87, pp. 90, 98.
-
1984
1981
1982
1983
1984
18.5
32.4
24.5
32.6
26.2
31.8
18.3
32.7
_ 44 -
Table 8
Real Wage Per Employeeand Per CapLta ConsumptLoD
1. Per capita
consumption
2. Real wage (gross)
3. Real wage (net)
1981
1982
1983
1986 1987
1984
1985
Annual rate of change (Z)
10.5
11.1
15.2
5.7
-0.9
-2.9
6.1
4.7
3.1
-8.6
-2.5
-6.8
-1.0
-6.8
-2.2
12.5
11.6
13.5
Sources AR87, ch. 4.
2. and 3.s Private and public sector.
Table
9
Durable and Won-durableConsumption
1. Durable purchases
as percent of total consumptLon
2. Annual lncrease (S) in
constant prLcest
a. durable purchase
b. non-durableconsumptLon
Source: A£87, p. 28
2. is ln current prLces.
1986
1987
1984
1985
9.7
8.5
10.6
11.0
-31.5
-2.5
-0.7
0.7
47.1
10.2
12.6
7.6
6.3
8.2
7.7
-
45
-
Table 10
Component. of GNP in 1981 - 1987
(Z of GNP (current prices])
1. Private
consumption
2. Public
consumption
(domestic)
3. Gross
Investment
4. Import
surplus
5. Gross nat. saving
out of GNP
6. Current
account
7. Gross nat. saving
(total)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1981
1982
1983
1984
1985
1986
1987
(8)
19811984
(9)
55.1
56.7
58.2
55.5
57.7
6C.9
61.9
56.4
+5.5
33.2
31.1
30.7
32.1
28.4
26.1
25.9
31.8
-5.9
21.3
23.1
23.2
22.1
18.4
19.1
19.2
22.4
-3.2
9.6
10.9
12.1
9.7
4.5
6.1
7.0
10.6
-3.6
11.7
12.2
11.6
12.4
13.9
13.0
12.2
12.0
0.2
-4.0
-8.3
-7.9
-6.8
4.8
2.9
-0.8
-6.8
6.0
17.3
14.8
15.3
15.3
13.6
16.2
18.4
15.6
2.8
(7) - (8)
Calculated from data base of Research Department of Bank of Israel
4. Converted dollar values to shekel by average official
exchange
for each year.
Same calculation
used for nominal GNP. Import
excludes
direct
defense
imports.
Items
(1),
(2)
and (5) add up to unity.
(1) + (2) + (3)
Table
Domestic
1. Private
consumption
2. Public
consumption
3. Gross
investment
4. Total domestic
uses
Uses as Percent
rate
surplus
- (1) - (4).
(7) - (3) + (6)
11
of GNP in Constant Prices
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1981
1982
1983
1984
1985
1986
1987
(8)
19811984
56.9
60.7
64.1
58.3
56.6
62,5
64.3
60.0
4.3
30.5
31.1
31.0
30.7
29.3
27.4
26.5
30.8
-4.3
20.5
23.3
25.0
22.7
19.6
20.7
20.4
22.9
-2.5
107.9
115.1
120.1
110.6
111.2
113.7
111.7 105.5
Sourcet Research Department. Bank of Israel, Data Base. Line 4 minus 100
imports)
in constant
(excluding
defense
yields
the Import surplus
to GNP.
relative
prices
(9)
(7) - (8)
-2.5
-
46 -
Table 12
Balance of Payments of the Private Sector, 1981 - 1987
(millions$)
1.
2.
Current
account
Basic
account
3.
4.
5.
Errors and
omnissions
Purchaseof
foreign
exchange
from Bank
of Israel
Derived Capital
import
1985
II
I
1985 1986 1987
-2,069 -1,442
-217 -51
-268 -769 -940
-1,000 -1,269
-254 -40
-294 -616 -609
-1.022
-418
-433 197
-236
231
161
512
1,588
2,000
677 105
782
659
99
883
480
-558
-406
110
840
1981
1982
1983
-434
-1,395
-489
-1,515
38
40
380
54
1984
-460
54
Sources Years 1981-1984: AR86, p. 202; 1985: AR85, p.225;
1986 - 1987: AR87, p. 189
The data from the differentannual reports are not fully
consistentwith each other because of revisions.
Table 13
SelectedPrices Indices,1985-1988,Quarterly
(annualizedrates of change (Z) within period)
1.
2.
3.
4.
Consumer
price indez
Controlled
pricesga
Industrial
price index
Exchage rate
NIS/currency
basker
1987
II III IV
I
1986
II III IV
221 362 247 29
8
30 13 30
19 16 10 19
18
456 464 416 -2
9
46 13 10
22 14 16
9
13
205 233 203 33
16 22 11 12
32 14 18 20
17
241 279 126 14
8
8
5
3
I
60 -1
Sources AR86, p. 51 and AR87, p.50
a.
1988
I
1985
II III IV
I
The index of controlledprices comprises some 'basic'foodstuffs
and public utilities. It covers about 26Z of CPI.
0
7
2
- 47
-
Table 14
Nominal and Real
Schekel
exchangerate
atainst
Dollar
(1)
5-curr.
basket
(2)
ExchangeRates
1985
Relative
price of
Relative
price of
exportgal
imnortsbi
(3)
(4)
-
1988
Real Wages
rate per unit
of outputcl
(5)
I
II
III
IV
0.733
1.015
1.487
1.481
0.572
0.827
1.273
1.329
115
113
110
107
89.1
83.9
75.5
80.0
1986
I
1I
III
IV
1.486
1.485
1.491
1.489
1.387
1.420
1.481
1.445
108
97
98
97
104
97
100
99
96.7
101.2
97.2
104.9
1987
I
1I
III
IV
1.601
1.597
1.608
1.573
1.660
1.679
1.678
1.697
101
95
94
94
103
94
96
96
100.3
102.8
102.9
113.1
1988
I
1.575
1.717
116.7*
Source: AR87, p. 53, 179.
a/ b/ Prices of exports and imports in domesticmarket relative to price
index of domesticuses.
In industry. Deflatedby dollar price of industrialexport at effective
rate for export.
*
Preliminary.
PPR WorkingPaper Series
Title
WPS70
WPS71
WPS72
VocationalEducationand Economic
Environments: Conflictor
Conve-gence?
School Effectson StudentAchievement
in Nigeria and Swaziland
The RelativeEfficiencyof Public
Schools in DevelopingCountries
WPS73
Taxationand Output Growth in Africa
WPS74
Fiscal Stabilizationand ExchangeRate
Instability: A TheoreticalApproach
and Some Policy ConclusionsUsing
MexicanData
WPS75
WPS76
WPS77
WPS78
WPS79
WPS80
WelfareDominanceand the Design of
Excise Taxation in the Cote d'lvoire
On the Shadow Price of a Tax
Inspector
Author
Date
Contact
Arvil V. Adams
AntoineSchwartz
August 1988
T. Hawkins
33678
MarlaineLockheed
Andre Komenan
August 1988
T. Hawkins
33678
EmmanuelJimenez
MarlaineLockheed
VlcentePaqueo
August 1988
T. Hawkins
33678
JonathanSkinner
August 1988
A. Bhalla
60359
Andrew Feltenstein
StephenMorris
August 1988
A. Shalla
6035)
Shlomo Yitzhaki
Wayne Thirsk
August 1988
A. Bhalia
60359
August 1988
N. Campbell
33769
Shlomo Yitzhaki
Yitzhak Vakneen
IncentivePoliciesand Agricultural
Performancein Sub-SaharanAfrica
Bela Balassa
and Trade
Economists,Institutions
Restrictions: A Review Article
J. Michael Finger
QuantitativeAppraisalof
AdjustmentLending
Bela Balassa
August 1988
N. Campbell
33769
Emerging Issuesof Privatization
and the Public Sector
Samuel Paul
September1988
E. Madrona
61711
°PR WorKingPaper Series
Title
WPS81
ReachingPeople at the Periphery:
Can the World Bank's Population,
Health,and Nutrition^perations
Do Better?
WPS82 Microeconomic Theory of the Household and NutritionPrograms
WPS83 Welfare Costs of U.S. Quotas in
Textiles,Steel, and Autos
WPS84
Black Markets for ForeignExchange,
Real Exchai,ge
Rates and Inflation:
Overnightvs. Gradual Reform in
Sub-SaharanAfrica
WPS85 Wage Responsiveness and Labor Market
Disequilibrium:Exploringthe
Componentsof Open Unemployment
WPS86
WPS87
WPS88
WPS89
WPS90
WPS91
ExternalBalance,Fiscal Policy and
Growth in Turkey
Vocationaland TechnicalEducation
in Peru
Costs, Payments,and Incentivesin
Family PlanningPrograms
ExportQuota Allocations,Export
Earningsand Market Diversifications
A Frameworkfor Analysisof Mineral
Tax Policy in Sub-SaharanAfrica
Israel'sStabilizationProgram
Author
Date
Contact
RichardHeaver
September 1988
S. Ainsworth,
31091
Dov Chernichovsky
Linda Zangwill
September 1988
S. Ainsworth
31091
Jaime de Melo
David Tarr
September 1988
C. Cabana
61539
Brian Pinto
September 1988
R. Blade-Charest
33754
John A. Ross
StephenL. Isaacs
September1988
S. Ainsworth
31091
Taeho Bark
Jaime de Melo
September1988
C. Cabana
61539
Robert F. Conrad
Zmarak M. Shalizi
September1988
A. Bhalla
60359
Nissan Liviatan
September1988
N. Liviatan
61763
Ramon E. Lopez
Luis A. Riveros
Ritu Anand
Ajay Chhibber
Sweder van Wijnbergen
Peter R. Moock
RosemaryT. Bellew