The logic behind the Bank of Israel’s interest rate increase

Experts weigh in on the decision to increase the Bank of Israel’s key rate from 0.1% to 0.35%.

 Israeli money bills. (photo credit: PIXABAY)
Israeli money bills.
(photo credit: PIXABAY)

Since the onset of the COVID-19 pandemic, Israel - like many countries around the world - has experienced an array of economic challenges, from trade logistics issues to increased dependence on government finance. The impact of many of these challenges is reflected in the nation’s steadily increasing interest rate. In order to push the nation’s economy in a manageable direction, the Bank of Israel has increased its interest rate for the first time since 2018, from 0.1% to 0.35%.

The decision, which has been planned for several months, was implemented on Monday and is expected to ease the current demand for government loans. To the end consumer, this looks like less accessible loans from the bank, but it also means that, if the BoI’s plan works, there will be a curb on price-rises as less money is fed into the economy.

“The idea underlying the interest rate increases is to make borrowing more expensive, and thus reduce it,” said Prof. Dan Ben-David, head of the Shoresh Institution for Socioeconomic Research and an economist at Tel-Aviv University.

He explained that, as a result of the pandemic, the government was eager to inject more and more money into the economy in order to prevent excess damage; however, that decision has led to an inflation rate that has gradually increased the cost of living for Israelis. As such, Ben-David suggested that the government’s eagerness to “throw money” at the problem was misplaced.

“Recovery from one-time shocks like wars – and pandemics – tends to be much quicker and stronger than after recessions caused by inherently economic problems. The original economic problem – the COVID recession – has almost completely evaporated, but the major infusion of money is still around and it is causing inflation,” said Ben-David. “Exacerbating this problem are the supply chain misfirings and together, we have all of the ingredients for rising prices.”

Money.  (credit: POLICE SPOKESPERSON'S UNIT)Money. (credit: POLICE SPOKESPERSON'S UNIT)

Professor Karnit Flug, vice president of the Israel Democracy Institute and the former governor of the Bank of Israel, elaborated on the current state of inflation: “Inflation has risen. The latest reading for the last 12 months was 3.5% inflation - slightly over the upper bound of the target range, which is between 1% and 3%. It's much, much higher than it was before,” she said. “It's much more modest than, for example, the US which is at around 7%, and the average for OECD countries which is close to 6%; but still, it's a significant rise.”

Rising inflation isn’t the only reason that the BoI has chosen to increase its interest rate, said Flug. “The economy is growing very fast, the labor market is becoming tight; wages are going up. It seems like the economy is getting hotter,” she said. “It’s extremely expansionary, and there are good reasons to start withdrawing the support by the monetary policy for the economy, basically in order to make sure that inflation doesn’t actually accelerate.”