Shocks and Currents: Monetary Policy and Israel’s Foreign Exchange Market

Itamar Caspi, Amit Friedman () and Sigal Ribon ()
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Amit Friedman: Bank of Israel
Sigal Ribon: Bank of Israel

Comparative Economic Studies, 2024, vol. 66, issue 3, No 4, 454-481

Abstract: Abstract This paper explores the interplay between domestic and global monetary policies, capital flows, and exchange rate dynamics in Israel. Using a novel dataset of daily sectoral FX transactions, we examine the transmission of monetary shocks identified from yield curve shifts around central bank announcements. Local projections reveal that foreign financial investors respond strongly and symmetrically to domestic and foreign shocks, which suggests that they react to the interest rate differential. Domestic institutional investors counteract this by rebalancing their portfolios. In particular, the impact of US monetary shocks on Israeli institutional investors and on the exchange rate depends on the shocks’ correlation with the S&P 500 stock index. The findings contribute to a deeper understanding of the mechanisms through which domestic and global monetary policies influence small open economies like Israel, and highlight the limited monetary autonomy of small open economies even under flexible exchange rates.

Keywords: Monetary policy; Exchange rate; Capital flows; Yield curve; Small open economy; High-frequency identification; Israel (search for similar items in EconPapers)
JEL-codes: C32 E52 F31 F37 F41 G15 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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DOI: 10.1057/s41294-024-00236-y

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