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Housing prices (representing rents) and energy prices in the Consumer Price Index (CPI) tend to respond more than other components to changes in the Bank of Israel interest rate. |
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In response to an increase of 1 percent in the interest rate, the pace of increase in housing prices (rents) is expected to decline, after a year, by about 1 percent. Energy prices react similarly. The pace of increase of the overall index is expected to show a moderation of 0.9 percent after one year. Food, shoes, and clothing prices are expected to moderate by only 0.5 percent. |
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The effect of the interest rate on CPI components is primarily through its effect on the exchange rate. An increase in the interest rate is expected to be expressed in an appreciation of the shekel which contributes to a moderation in the rate of price rises. |
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In response to (an unexpected) depreciation of the shekel vis-?-vis the dollar, there is an acceleration in the pace of price rises, though here, too, the immediate response of prices of various components is not identical in strength. In response to a 1 percent depreciation, housing prices (rents) are expected to increase in the short term by 0.1 percent, as opposed to 0.7 percent in the last decade |
| A research paper by Dr. Sigal Ribon from the Bank of Israel Research Department which examines the effect of monetary policy on the Consumer Price Index (CPI) finds that an interest rate increase is reflected in a moderation in the rate of increase of prices of all components of the index, and that the effect on the housing and energy components is greater than the effect on other components. It also found that shekel appreciation is expressed by a slowdown in the pace of price increases in all sections, and its effect on tradable goods, including energy items, is stronger. |
| Within the framework of the process of reaching monetary policy decisions, the Bank of Israel considers and follows a very wide range of indicators and data. However, in macroeconomic models the reference is generally to the overall CPI and its main subgroups. The method presented in the research paper, based on similar research around the world, makes it possible to examine the effect of changes in the interest rate and exchange rate on each component of the CPI, in addition to the effect on the overall index. |
| An examination of the effect of an (unexpected) change in the Bank of Israel interest rate or in the shekel-dollar exchange rate on each of the 38 subsections of the CPI shows that the pace of change in prices for all the subsections (excluding fresh fruit) slowed in reaction to an increase in the Bank of Israel interest rate, though the strength of the immediate response is not identical. In response to an increase of 1 percent in the interest rate, the pace of increase in housing prices (representing rents) is expected to decline, after about one year, by 1 percent. Energy prices are expected to respond similarly, though price rises of food, and shoes and clothing are expected to only decline about 0.5 percent. The pace of increase in the overall index is expected to moderate by 0.9 percent after a year. |
| In response to (an unexpected) deprecation of the shekel vis-?-vis the dollar, the pace of price increases accelerates. However, here too, the immediate response of prices of various subsections is not uniform in its strength. In response to a 1 percent depreciation, housing prices are expected to increase in the short term by 0.1 percent. A similar quantitative response is expected in the housing maintenance and furniture and household equipment subsections. The housing maintenance subsection includes electricity which is directly affected by changes in the exchange rate, and the furniture and home equipment subsection includes imported products whose price is dependent on the exchange rate. |
| The response of the housing component, about 0.1 percent, is significantly lower than that estimated in the previous decade, which was 0.7 percent. The response of the housing component reflects the historical connection between the exchange rate and rent prices through the end of 2007, as a result of the routine practice then of denominating rental contracts in dollars. As a result, every change in the exchange rate was reflected immediately in rent levels, and thus in the housing component of the CPI. In recent years, the connection was severed and today, only about 5 percent of rental contracts are denominated in dollars. At the same time, the effect of the exchange rate on housing prices weakened very much in recent years |
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