Israel is notorious for inflation, which steadily increased since 1960. Inflation averaged 5 percent a year between 1960 and 1972. It accelerated sharply to an annual average rate of 32 percent in the mid 1970s to 70 percent during the late 1970s and to a hyperinflationary annual average exceeding 200 percent during the first half of the 1980s. In the latter part of 1984, monthly rates of inflation surpassed 1,000 percent in annualized terms.

In July 1985, the Government of Israel imposed a stabilization plan designed to extricate the country from the economic dangers of accelerating hyperinflation. In Policy Studies No. 9, Professor Yakir Plessner, former Deputy Governor of the Bank of Israel, assesses the conduct of monetary policy by the Bank of Israel in the aftermath of the stabilization plan. He notes that post-1985 monetary policies have failed to achieve stability. Inflation has remained in a stubborn high range of 15-20 percent during 1985-1990.

Plessner demonstrates that the continued rise in wage rates in excess of gains in productivity, despite historically high rates of unemployment, has forced several devaluations of the shekel. The shekel's value has depreciated from an initial fixed rate of $1 = NIS 1.5 to about $1 = NIS 2.25, a loss of half. Plessner also argues that the mistaken imposition of high real interest rates following the implementation of the stabilization plan damaged overall economic activity.

Monetary stability is required to improve Israel's investment climate. Unpredictable devaluations encourage speculation against the exchange rate at the expense of productive business activity. High inflation imposes a risk premium on investment and discourages foreign direct investment.

Yakir Plessner is a Policy Analyst with IASPS, Professor of Economics at Hebrew University, Rehovot, and a frequent contributor to the Hebrew newspaper and Globes.