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An Estimated New Keynesian Model for Israel

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  • Argov, Eyal
  • Elkayam, David

Abstract

We formulate and estimate a small New Keynesian model for the Israeli economy. Our goal is to construct a small but still realistic model that can be used to support the inflation targeting process. The model contains three structural equations: An open economy Phillips curve for CPI inflation (excluding the housing component), an aggregate demand curve for the output gap and an interest parity condition for the nominal exchange rate. The model is closed with an interest rate reaction function (Taylor-type rule) and an ad hoc equation for the housing component of the CPI, which is dominated by exchange rate changes. In the specification of the model we had to pay special attention to the crucial role of the exchange rate in the transmission of monetary policy in Israel, which has a direct effect on almost 60 percent of the CPI. The model is estimated by the GMM method, using quarterly data for the period 1992:I to 2005:IV. In the estimation of the structural equations we tried to remain as close as possible to the theoretical formulation by restricting the dynamics to one lag at most. We use the model to characterize an "optimal" simple interest rate rule. We find that the monetary authority should respond to an hybrid backward-forward looking rate of inflation and does not benefit from direct reaction to exchange rate measures.

Suggested Citation

  • Argov, Eyal & Elkayam, David, 2007. "An Estimated New Keynesian Model for Israel," MPRA Paper 9412, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:9412
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    References listed on IDEAS

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    Cited by:

    1. Argov, Eyal & Binyamini, Alon & Elkayam, David & Rozenshtrom, Irit, 2007. "A Small Macroeconomic Model to Support Inflation Targeting in Israel," MPRA Paper 4784, University Library of Munich, Germany.
    2. Benchimol, Jonathan, 2016. "Money and monetary policy in Israel during the last decade," Journal of Policy Modeling, Elsevier, vol. 38(1), pages 103-124.
    3. Zvi Eckstein & Guy Segal, 2010. "Monetary policy in response to imported price shocks: the Israeli case," BIS Papers chapters,in: Bank for International Settlements (ed.), Monetary policy and the measurement of inflation: prices, wages and expectations, volume 49, pages 209-232 Bank for International Settlements.
    4. Tibor Hledik & Sultanija Bojceva-Terzijan & Biljana Jovanovic & Rilind Kabashi, 2016. "Overview of the Macedonian Policy Analysis Model (MAKPAM)," Working Papers 2016-04, National Bank of the Republic of Macedonia.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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