For Israel, No Inflation Is No Big Deal

(Bloomberg) -- The specter of deflation has driven central banks around the world to stretch monetary policy to get prices rising. In Israel, where the inflation rate has been negative for 24 consecutive months, some economists are actually applauding.

That's because unlike in Japan or Europe, falling prices don't reflect sagging demand, but rather government policy. Since demonstrators took to the streets in Tel Aviv five years ago to protest rocketing charges for housing and food in what was then a very closed economy, successive governments have focused on lowering prices in areas where it holds sway. 

In recent years, the government has slashed prices for things like bus tickets, water and electricity. Other industries, such as air travel or food, which were previously insulated from the global market, have been opened to new competitors, helping prices to fall.

That's had a huge impact on consumers, who suddenly have cheaper and more ample choices, from airfares to mobile phones to car insurance. So as the economy technically appears to be heading toward deflation, with a sustained period of price drops, growth is healthy. QuickTakeFor the lowdown on deflation click here.

Last quarter, booming consumption helped the country grow an annualized 4.3 percent. Ori Greenfeld, chief strategist at Tel Aviv-based Psagot Investment House Ltd., says it no longer makes sense to watch headline inflation. Instead, he says, look at the Bank of Israel estimate which strips out government measures and energy prices.

“If prices are going down because Israel is suddenly experiencing a healthy bout of competition and the government is fixing things that were broken for years, the Bank of Israel can say, ‘This is not something I should step in to fix,”' he said. “If your goal is to get into the central bank's mind and understand where they'll go next, I'd be looking at the core number instead.”

Like central banks around the rich world, the Bank of Israel has considerably eased its monetary policy, pushing down interest rates to 0.1 percent. But its chief concern was to protect its currency, which would have appreciated even more than it already has if Israel allowed for a substantial interest rate gap to build. Now, even as prices continue to drop, economists expect the next move -- perhaps not until late 2017 -- will be a rate increase.

To contact the author of this story: David Wainer in Tel Aviv at dwainer3@bloomberg.net.

To contact the editor responsible for this story: Jeff Black at jblack25@bloomberg.net, Zoe Schneeweiss