Author: Paweł Kowalewski

Economist, works at NBP, specialises in monetary policy issues and FX markets

Between Tel-Aviv and Jerusalem, with shekels in your wallet

Most often we get to hear about the dollar, the euro or the Swiss franc. The pound will get a mention now and then, and sometimes the yen. The press often reports on emerging currencies, such as the Turkish lira, the Russian ruble or some Latin American currency. But hardly ever do we get to hear anything about the Israeli shekel. This is a pity.
Between Tel-Aviv and Jerusalem, with shekels in your wallet


It is unlikely that the shekel will rise to rank enjoyed by the currencies mentioned at the beginning of my text  in any near future, or aspire to the position of a pillar of the international monetary system. However, there are many indications that its role will become increasingly significant. Certainly, if we trace the history of the shekel’s exchange rate, we will conclude that it can compete for the title of the strongest currency in the world.


The foreign exchange market is a specific place demonstrating high volatility. Assessing the position of a particular currency based on the behaviour of its exchange rate is a rather risky task. Due to the volatility of this market, a currency that gains over six months can suffer heavy losses over the subsequent three months. We therefore need a relatively long period to perform such assessment. The Israeli currency has been gaining almost since the beginning of this century, and the appreciation has gathered pace over the last fifteen years.

Interestingly, neither the financial crisis of 2008 nor the pandemic of last year put end to it. On the contrary, both events became a kind of a catalyst boosting the appreciation trend. The only currency that can keep pace with the Israeli currency, albeit with difficulty, is the Swiss franc. The comparison alone may surprise or even shock. On the one hand, a country plagued by constant political instability and located in the proverbial eye of the cyclone in the Middle East, and on the other hand, a country perceived as an oasis of stability in each and every respect and widely acknowledged as a haven of safe shelter. Furthermore, the paradox does not end there. While the Swiss franc is kind of high on the proverbial steroids (or, to be more precise, on the steady inflow of de facto  speculative capital), which is a source of anxiety for the Swiss central bank, the shekel is supported by robust economic growth, and its appreciation bears all the signs of structural features.

However, before we look at the Israeli currency from the point of view of the current situation, let us look at its history. This will allow us to expand our knowledge of the currency and also to capture the turning point at which the Israeli currency had ceased to be just another weak and therefore insignificant currency and grew to become the strongest currency in the world today.

Difficult beginnings

As we very well know, the State of Israel was established in 1948 and its beginnings were not easy. This situation was bound to have some effect on the new state’s currency. At the very beginning, its official name was the Israeli pound and its quotations were linked to those of the British pound. In the first years of its existence, the monetary authorities did not even conceal the fact that their attention was on other matters than the stability of the new money. It was a period when the newly formed state was open to those who had survived the horrors of the Holocaust. The population therefore grew at a breath-taking rate. The new arrivals had to be guaranteed the conditions that would enable them to start a new life. The authorities printed money disregarding any considerations. The most important thing was to ensure the survival of the newly formed country. And yet, even before the arrival of visitors from various parts of the world, the first Arab-Israeli war had to be confronted. Perhaps that is why the Israeli economy was characterised by a very long period of tight regulation.

The central bank of Israel was not established until 1954. For almost the first two decades of its existence, the new central bank handled things with mixed success, and the average inflation for this period was slightly above 5%. This was higher than in other Western European countries or the USA. However, these were great times for a vast majority of the population, people traumatised by the Holocaust. The average GDP growth was around 10 per cent, unemployment was low and living conditions were indeed improving rapidly. Of course, such a high economic growth was primarily driven by the US support as well as reparations paid by Germany.

People living there learned to live with slightly higher inflation through the mechanism of price indexation almost ubiquitous in their lives.

As to the slightly higher inflation, Israeli people learned to live with it with the help of the almost ubiquitous price indexation mechanism. This mechanism became increasingly useful to Israelis, for whom tracking inflation has become a kind of national sport.

Hurdles begin and crisis ensues

Relative price stability ended with the onset of the 1970s. This decade was marked by high inflation almost everywhere in the world. In Israel, however, it was exceptionally high. The first oil shock triggered its rise to 40%, after which a slight decline took place, but in 1979 inflation jumped to 50%, and a year later it hit almost 80%. Admittedly, Israel did not only struggle with the consequences of the oil shocks. The Six-Day War of 1967, the Yom Kippur War of 1973, and the wars of attrition meant – even though Israel emerged victorious from them – a huge burden on the national budget. Between 1973 and 1976, the share of military expenditure in the broad sense  reached almost 30% of GDP.

To make matters worse, Israel began liberalising capital flows in the late 1970s. Despite the prior floating of the exchange rate, the whole operation failed. The 1980s began with the introduction of a new currency with a name referring this time to the proverbial roots – the shekel. Its introduction was probably intended to neutralise the high inflation of the 1970s, as 1 shekel was worth 10 Israeli pounds.

Which mode of transport was cheaper to cover the distance between Tel Aviv and Jerusalem, a bus or a taxi? The correct answer indicated a taxi. In the mid-1970s, inflation reached almost 500%.

While the Western world strenuously but persistently strove to win the battle against inflation, Israel regressed. By 1980, inflation had jumped to approximately 130% and was not about to say the last word. The first half of the 1980s coincided with a period of very high inflation, which reached almost 500% at its peak. It is these days that the joke about the cost of travelling from Tel Aviv to Jerusalem dates from. The joke was about answering the question regarding the mode of transport which was cheaper to cover the distance between the two cities, a bus or a taxi. As one might guess, the correct answer was a taxi. The point was that it was necessary to pay a fixed price in advance for a bus ticket, whereas in the case of a taxi one only paid at the end of the journey. It was then that people started to say that Israelis follow the CPI like Americans follow the NBA results.

Laborious recovery from the crisis

In July 1985, another new economic plan called the Economic Stabilisation Policy was announced. Many people were doubtful about the effectiveness of this plan, especially as measures initiated at the same time in other countries (Brazil or Argentina) to combat high inflation proved unsuccessful. Within the framework of the programme described above, it was decided to introduce huge budget cuts and a major devaluation of the shekel (in order to prevent a balance of payments crisis) However, the most important element of this programme was the social agreement through which all parties decided to freeze prices. Despite a lot of social scepticism, the plan worked, and in early 1986, the decision on currency denomination was taken, as a result of which a thousand old shekels had to be put on the table in order to acquire a new Israeli shekel. This brings us to the currency which is the main subject of this text.

In early 1986, the decision on currency denomination was taken, as a result of which a thousand old shekels had to be put on the table in order to acquire a new Israeli shekel.

The new programme had certainly inhibited the rapid erosion of the value of Israeli money but it had certainly failed to stabilise it. Throughout the second half of the 1980s, inflation fluctuated slightly below 20%, although in 1989 it exceeded that ceiling as well. This should not surprise anyone. Firstly, it is difficult to stabilise a currency in the blink of an eye. Secondly, fate did not spare the shekel (nor the country as a whole). At first, political instability reached its peak with the Palestinian intifada, followed by a replay of history (or more precisely, the very beginning of the modern state), i.e., a massive influx of people after the collapse of the USSR. Let us quote some figures. While in 1972-1982 the total number of immigrants reached „only” about 325,000 people, in 1990-1999 it exceeded the million-person ceiling and amounted to 1,050,000.

Under the circumstances it was really difficult to stabilise the currency. Therefore, on the announcement of the new programme, the shekel was devalued, as early as January 1987. Another devaluation took place at the end of 1988 and in March 1991. The 1990s also saw recourse to the crawling peg formula, which was also applied in Poland at almost the same time. And, as we remember from our experience, the formula is aimed not only at disinflation but also at maintaining competitiveness in foreign trade. Therefore, a single-digit inflation rate was only achieved in the late 1990s. In 1997, a significant expansion of the fluctuation band took place, with some sources saying that even then, the actual floating of the exchange rate occurred.

A single-digit inflation rate was not reached until late 1990s. In 1997, a significant expansion of the volatility band took place, with some sources saying that even then, the actual floating of the exchange rate occurred.

Bank of Israel supports the path to economic success

It may have been a coincidence, but it was precisely in the second half of the 1990s that the long and strenuous path of structural transformation that took the shekel exchange rate so high first started. For some time now, the Israeli economy has been attracting a huge number of new start-ups. The country started to specialise in the high-tech industry. The success of this industry is one of the main reasons for the strong inflow of capital into the country this year. In the first half of 2021, more than 37 billion US dollars due to investment by non-residents flowed into Israel.

The importance of the high-tech sector is so high that questions are arising as to whether the national economy is possibly becoming too dependent on this particular sector. Others go even further and claim that too much reliance on the high-tech sector may lead to the risk of creating a modified (adjusted for the realities of the 21st century) version of the Dutch disease.  This raises the question of the role of the central bank responsible for the monetary policy.

The essence of this role was best expressed by the Governor of the Bank of Israel, Professor Amir Yaron, in one of his recent speeches. In his opinion, the central bank managed to create a climate which mitigated the effects of  the fact that the locus of the Israeli economy was shifting from manufacturing to services (for example, by maintaining a high level of employment). It is difficult to disagree with Professor A. Yaron. So, how did the Bank of Israel manage to fulfil its task, which involved preventing an excessive appreciation of the national currency?

Thus, how did the Bank of Israel manage to fulfil its task, which involved preventing the excessive appreciation of the national currency?

As early as 24 March 2008, the Bank of Israel announced a plan for a major expansion of its foreign exchange reserves. Until then, the Israeli foreign exchange reserves had fluctuated around approximately 10 billion US dollars. The announced new target level was to range between 35 and 40 billion dollars, with an increase of 10 billion dollars (i.e., their actual doubling) to be achieved – according to the original assumptions – within about two years. Moreover, purchasing foreign currency also means controlling the growth rate of appreciation. The strategy of increasing Israel’s foreign exchange reserves was to be implemented gradually and systematically through, among others, daily purchases of foreign currency amounting to approximately 25 million US dollars. On 10 July 2008, the daily rate of purchases was increased to 100 million US dollars, while in November of the same year, the target range for future foreign exchange reserves was raised to 40-44 billion US dollars.

In 2013, the Bank of Israel decided to include in its intervention currency purchases the revenues which the natural gas extraction sector had begun to generate for the national economy. In its May 2013 statement, the central bank stated that further appreciation of the shekel triggered by high revenues from gas exports could even lead to the Dutch disease syndrome. Hence the decision to take the measures described here.

The amounts that the Bank of Israel bought under these measures varied. Initially, the annual amount of currencies purchased reached the level of 2.1 billion USD, in 2014-2015 it peaked at 3.5 billion USD and then its reduction started (from 2016) to the ceiling of 1.8 billion USD. The implementation of the programme described here continued until the end of 2018, when the programme was replaced by a new programme called The Fund for Israel’s Citizens. The newly created fund is a classic sovereign wealth fund specialising in overseas investment of the proceeds generated by gas extraction.

The implementation of the plans announced in March proceeded very quickly. As early as March 2010, the level of reserves achieved reached 23 billion USD, while the original target range (in the order of 35-40 billion USD) was met in December 2015. On the other hand, the threshold of 40 billion USD was exceeded in January 2018, while the top end of the range revised in autumn 2008 (44 billion USD) was surpassed in January 2020.

Bank of Israel and COVID-19

The Bank of Israel continued its policy of monetary intervention throughout most of the first shock of the COVID-19 pandemic. The latter did not omit Israel. Therefore, the central bank did not hesitate to resort to an unconventional monetary policy. Its most important element was the purchase of government bonds. In addition to government bonds, the central bank also purchased corporate bonds and granted long-term loans to the banking system with a view that domestic banks should lend the funds thus received to small and medium-sized enterprises.

After the panic of March 2020, the Israeli currency quickly resumed its appreciation trend. One of the key factors was the decision to include Israel in the World Government Bond Index (WGBI).

The recourse to unconventional monetary policy has by no means depreciated the shekel in the medium term. After the panic of March 2020, the Israeli currency quickly resumed its appreciation trend. One of the key factors behind such a state of affairs was the decision to include Israel in the World Government Bond Index (WGBI). It is worth mentioning that for the shekel the prerequisite was both the announcement of this decision (autumn 2019) and its implementation in April 2020. The value of foreign currencies purchased throughout 2020 amounted to 21.2 billion US dollars. Foreign exchange reserves in the same period increased from 435 billion shekels (approx. 126 billion US dollars) to 557 billion shekels (approx. 173 billion US dollars). The value of currencies purchased in 2020 was equal to the total value of foreign currency purchases in 2016-2019. Another factor underlying the appreciation of the shekel was the decline in the country risk measured by CDS spreads.

During the first nine months of 2021, the foreign exchange reserves of Israel increased by another 100 billion shekels (or approx. 30 billion US dollars). The beginning of 2021 marked the start of a sharp appreciation of the shekel, resulting in the Bank of Israel responding with an announcement on 14 January this year the content of which indicated that the bank intended to purchase 30 billion US dollars in the current year. By 19 July 2021, the Bank of Israel carried out a cumulative purchase of foreign currency amounting to 25 billion US dollars.

The strong appreciation of the shekel also translates into the inflation rate. Its level last year was minus 0.7%. However, the negative inflation rate was primarily the result of the pandemic (and the decline in GDP reached 2.4%). In 2021, inflation moved into the positive territory again. Its reading in October this year stood at 2.3%, thus inflation is now already contained within the central bank’s inflation range (from 1 to 3%). The rise in inflation this year did not and so far has not translated into inflation expectations.

Inflation is now already contained within the central bank’s inflation range (from 1 to 3%). The rise in inflation this year did not and so far has not translated into inflation expectations.

The shekel has also started to perform better on global currency markets. While back in 2004 the average daily turnover in this currency was just two billion US dollars, in 2019, it rose to 20 billion US dollars. Maybe the 2019 level itself is still not particularly high (it is still less than half of the daily average share with the zloty), nevertheless the growth is impressive, especially since as recently as 2010 the turnover for the shekel was only 6 billion US dollars.

In conclusion, after many decades of turbulence, it seems that good times have arrived for the Israeli shekel. Its appreciation over fifteen years speaks for itself.

It is not the result of a passing fascination with the shekel on the part of short-term capital.  It is rather a consequence of massive structural changes occurring in the Israeli economy.

The role played by the Bank of Israel cannot be overestimated here: it made every effort to ensure that the appreciation did not get out of hand and consequently did not harm the economy. It is worth mentioning that for a period of forty years, the Bank was headed by the true giants of world macroeconomics, starting with Michael Bruno, Jacob A. Frenkel and perhaps the most famous of them all, Stanley Fischer. It was under the tenure of the latter that the policy of controlled appreciation of the Israeli currency began. Therefore, it is very likely that the shekel will continue to gain in importance.


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