| A paper by Balfour Ozer, Shelly Reiss and Yoav Soffer of the Bank of Israel Foreign Exchange Activity Department prepared for the European-Mediterranean workshop of the European Central Bank held in October 2005 describes the process of liberalization in Israel's financial account that took place between the mid-1980s and 2005, and analyzes its effect on Israel's economy. |
| The analysis shows that liberalization contributed to the economy's openness, to the expansion of activity in the financial account, and to the improvement of the economy's financial standing. In addition, the increased involvement of nonresidents in Israel's capital and foreign-exchange markets served to enhance those markets. Nonetheless, although liberalization gave nonresidents' short-term capital flows a significant boost, mainly via derivatives, it did not increase the volatility of the exchange rate, which remains markedly lower than that of other advanced and emerging economies. |
| The paper also shows that liberalization did not increase the severity of financial crises, mainly because residents could purchase foreign-currency or foreign-currency-indexed assets even prior to the liberalization process. Moreover, liberalization and the increased flexibility of the exchange-rate regime raised the private sector's level of awareness of exchange-rate risk, and boosted its use of hedging instruments against this risk. In contrast, households have not yet internalized the fact that the exchange rate can move in both directions, and they are therefore seriously exposed to appreciation of the NIS. |
| A comparison of the success of this gradual and consistent liberalization process with the failure of the "instantaneous" liberalization of 1977 indicates the main reasons for that failure and shows how understanding them enabled a more successful process to be implemented: |
| At the end of the 1980s the macroeconomic background was more favorable and was improving; |
| The domestic capital markets were more developed, and there existed a data infrastructure on capital flows to and from Israel; |
| Monetary policy had moved to an inflation-target regime, alongside gradually increased flexibility of the exchange–rate regime; |
| There was a move from the use of administrative instruments to the use of market instruments, and policy instruments were gradually adjusted to deal with the removal of control of capital movements. |