Monday, June 4, 2012

Israel Targets NGDP

Shh...Don't look now, but Stanley Fischer, who has run the Bank of Israel since 2005, is targeting the level path of nominal GDP.What gives the Bank of Israel's NGDP level target away, to me, is the temporary increase in inflation in 2008 and 2009, which cancels out the slowdown in real growth such that NGDP growth is constant through the recession, and the tendency of monetary policy to correct for past errors to maintain a 6.5 percent year-over-year growth path; see the swing between 2006 and 2007. As real growth has slowed since the first quarter of 2011, inflation has been allowed to rise.

The idea that Israel may now be pursuing a de facto NGDP target is very exciting -- more real-world examples of the policy are needed, especially since the Bank of England has fallen off the bandwagon. Even better, Fischer has written several papers about monetary policy in which he appears more than a little sympathetic to the idea:
"It is also generally agreed that in the long run monetary policy should play a stronger role in the economy, with perhaps explicit adoption of monetary growth targets." ("The Inflationary Process in Israel," NBER, 1984)
"In the short run, monetary policy affects both output and inflation, and monetary policy is conducted in the short run--albeit with long-run targets and consequences in mind. Nominal- income-targeting provides an automatic answer to the question of how to combine real income and inflation targets, namely, they should be traded off one-for-one...Because a supply shock leads to higher prices and lower output, monetary policy would tend to tighten less in response to an adverse supply shock under nominal-income-targeting than it would under inflation-targeting. Thus nominal-income-targeting tends to implya better automatic response of monetary policy to supply shocks...I judge that inflation-targeting is preferable to nominal-income-targeting, provided the target is adjusted for supply shocks." ("Central Bank Independence Revisited," AER, 1995)
If the Bank of Israel is indeed de facto targeting the path of NGDP under Fischer, the results are impressive. The Israeli unemployment rate, over 9 percent when Fischer took charge, stands just above 5 percent today, having only increased 2 percentage points -- from 6 to 8 -- during the most recent recession, and the labor market recovery post-recession was swift. Civilian employment grew right through the recession.

Private final consumption expenditures were barely dented by the recession and quickly returned to their path, as have total retail sales. Manufacturing or industrial production has also grown steadily, without the pronounced unit-root drop seen in other developed nations whose central banks target the rate of inflation. (If anything, it seems that Israel's construction sector is growing a little too fast.)

Israel is a shining example of how successful monetary policy is at macroeconomic stabilization when it targets NGDP.


  1. If you are desperate to find examples of NGDP targeting you will find them wherever you look, but I seriously doubt that Fischer is pursuing such a target. The real unemployment number for Israel is much larger than 5%, because a significant part of the potential workforce has no interest in work and is being subsidized by the government. The cost of living in Israel is fairly high and just last summer about half a million people (out of a country population total of 7mil) protested against the high living costs in the country -> That's a generally good indicator of a faulty monetary strategy.

    As for consumption, the recession hadn't had a real impact on Israel because the banking sector is stable, exports are mainly done with the US and not with Europe, and BOI intervened in the FX market and purchased about 70b$ to weaken the ILS versus the USD. It's all oldschool monetary policy, nothing new or exciting under the sun. Sorry.

  2. Polymathon - You say two strange things in your first paragraph. 1 - that unemployment is actually higher than what's reported because of government subsidies, and 2 - that the high cost of living in Israel, which has resulted in large protests, somehow indicates a faulty monetary strategy.

    Neither of these facts in any way contradicts Evan's conclusion. So the government subsidizes some people. So what? In the US, there are millions and millions of people employed by the government, and the extent to which public employment creates economic inefficiency is an entirely different question from whether the central bank is accomplishing stabilizing the price level and promoting full employment. You than criticize the central bank for allowing "high living costs." Read Evan's post again. The BOI's willingness to let the price level increase, is part of what has stabilized nominal incomes and hence the Israeli economy.

    You're missing Evan's point. His argument is that Israel is one of the few countries, along with Australia, that has preserved nominal income growth stability in the face of falling real output. As a result, employment has remained high, and the recession was over quickly.

    Stanley Fisher was hailed because he was the first central banker to raise interest rates after the recession. But the reason he was able to do this was because the BOI kept income growth at ~5% during the recession, thus ensuring a speedier recovery.

    Evan, really terrific work. You're getting better and better.

  3. Hey Evan,

    Great blog, but this post leaves me feeling a little bewildered. I was under the impression that NGDP level targeting was supposed to work mainly through the expectations channel and as Israel maintains an official inflation rate target rather than an NGDP level one I can't quite see how this data supports NGDP targeting as a policy. Of course it is possible that Fischer has provided a sort of nudge, nudge, wink,wink signal to the markets that he is actually targeting NGDP but a (very) quick google of Bank of Israel policy announcements doesn't seem to show much evidence of this.
    I was wondering if you had any alternative mechanism than the expectations channel through which NGDP targeting could have been implemented in Israel.

    P.S Keep up the good work, this bog is amazing!

  4. What about Israel's dramatic increase in NGDP in 2005/2006? It makes sense from the perspective of lowering the unemployment rate, but I can't see how it makes sense from an NGDP-targeting perspective. I also think it was a smashing idea that was great for the Israeli economy.