The Bank of Israel - Vol. 1

By Haim Barkai; Nissan Liviatan | Go to book overview

16
General Features of the
Disinflation Process

RULES IN THE SERVICE OF PRICE STABILITY

Modern monetary disinflation strategy is based on rules that strive to ensure the attainment of price stability. The Maastricht criteria are an example of such a set of rules. In fact, the Israeli rules associated with the goal of price stability are patterned after these criteria, at least conceptually.

The first rule was the aforementioned “no-printing law,” which enjoins the Bank of Israel from lending money to the Ministry of Finance. This legislation severed the link between the BOI and the financing of the fiscal deficit and forced Finance to risk an increase in interest rates if it chose to finance the deficit by issuing bonds. Thus, it restricted the Finance Ministry’s ability to amass deficits. By excusing the BOI from having to maintain low interest rates on the national debt in order to help finance the fiscal deficit, it also contributed to the creation of monetary-policy independence.

The second rule was the 1991 Reduction of the Deficit Law, also mentioned above. Although this statute was never implemented as planned, it has helped to contain the deficit at about 4% of GDP on average since the early 1990s. From the 1985 stabilization until that time, the steep reduction in the defense budget and the high-growth years that followed lowered the debt/GDP ratio considerably. This process, however, stopped in the mid-1990s.

The third rule was the inflation target. Supposedly, the target regime reflected a consensus between the government and the BOI, the purpose of which was to lower the target over time until the attainment of price stability. Responsibility for managing the inflation target was entrusted to the central bank, which implemented a tight (overly tight, according to some critics)

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