Monetary policy rules in practice: The case of Israel

This paper presents a case study of how communication on monetary policy rules in Israel allows for discretionary deviations within a rule-like policy framework without impairment to central bank credibility. We quantitatively analyze a monetary policy rule that has described Bank of Israel policy formally since 2012 and informally since 2007. We demonstrate the value of a policy rule as a tool of communication and show how policymakers leverage this rule in times of economic uncertainty. We identify periods of discretionary deviation from the policy rule and show how communication on financial stability concerns derived from monthly interest rate announcements explains these deviations. Finally, we show how policymakers in Israel were able to anchor market expectations, even in times of great economic uncertainty. We assess how market expectations about the future path of the short-term interest rate respond both to communication related to the rule and exercised flexibility during the financial crisis. We use futures contracts on short term interest rates from the inter-bank market and find that monetary policy predictability improves in the period following the publication of this rule. We argue that policymakers in Israel were able to conduct monetary policy consistent with their main long-term objectives while maintain a high degree of transparency on assessments behind interest rate decisions.