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

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 announc...

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Bibliographic Details
Published in:Comparative economic studies 2024-09, Vol.66 (3), p.454-481
Main Authors: Caspi, Itamar, Friedman, Amit, Ribon, Sigal
Format: Article
Language:English
Subjects:
Capital movement
Central banks
Economics
Economics and Finance
Floating exchange rates
Foreign exchange markets
Foreign exchange rates
Foreign investment
Institutional investments
Interest rates
International Economics
International finance
Investors
Monetary policy
Political Economy/Economic Systems
Transactions
Yield curve
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Summary: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.
ISSN:0888-7233
1478-3320
DOI:10.1057/s41294-024-00236-y