The Bank of Israel said that it at one time considered abolishing representative exchange rates in order to limit dollarization in the Israeli economy. In its semi-annual Inflation Report for June 2006-January 2007, the bank warns against the ramifications from the spread of dollarization and linkage arrangements to the exchange rate. “Continuing partial indexation has economic implications both on monetary policy and on consumer welfare in the economy,” says the bank.
“The effect on monetary policy stems from the high and immediate pass-through from the exchange rate to the consumer price index, which stands at 29%. Continuing indexation makes managing monetary policy harder, as external shocks that are unconnected to Israel or sharp, frequent changes in the exchange rate also without any trend - make economic planning difficult and monetary planning particularly so. A prime example of this is the housing item, which has a 22% weighting in the consumer price index, the changes in which are closely matched to fluctuations in the exchange rate, and whose fluctuations are themselves greater that in the CPI in general.
“Furthermore, a relatively high pass-through of about 20 percent in non-tradable goods, with a sizable weighting in the consumer price index, harms the ability of the exchange rate to serve as a cushion for real shocks, expressed in changes in relative prices of tradable and non-tradable goods.
The Bank of Israel goes on to say, “The indexation of prices of goods and services in the economy to the exchange rate, in particular of non-tradable goods such as real estate, is expressed in consumers' exposure to depreciation and suppliers' exposure to appreciation. In most cases it is the ‘small consumer’ who is left exposed to fluctuations in the exchange rate. Even if there are defenses of one kind or another in the market, access to them is not simple and their cost is not small. An analysis of the banking system shows that the number of household transactions in futures and forwards is minimal. The general cost of currency protection for such rentals and house purchases to households, had such protection been provided through the banking system, was estimated at NIS 700 million a year.
“Pursuing a passive policy on dollar indexation in Israel to all intents and purposes means a continued potential threat on monetary policy targets. An active policy on this matter could be pursued gradually, together with a publicity campaign that would present the economic inadvisability of using foreign currency in the current economic conditions. As part of such a move, it has been proposed in the past to cancel the representative exchange rate that the Bank of Israel publishes daily, and which is regarded by the public as an official rate. This rate eases the use of the exchange rate as a unit of account, particularly as it is published so regularly, and apparently contributes to the perpetuation of partial dollarization in the economy.
Published by Globes [online], Israel business news - www.globes.co.il - on January 30, 2007
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