During the last two decades the Israeli economy underwent a gradual, consistent and successful process of liberalization in the financial account. This process was part of a strategy of increasing the openness of the economy in order to utilize the economy's growth potential. This paper analyses the sequence of the process from 1985 to 2005, and in the light of the failure of the big-bang liberalization in 1977. The paper also explores the effect of the liberalization process on two events undermining financial stability, and examines the macroeconomic impact of liberalization on the Israeli economy.
The sequence in which the liberalization process was implemented was consistent with the concept of slower progress in capital outflows and short-term instruments, as compared to faster progress in capital inflows and long-term instruments. The order by sector affiliation gave priority to the business sector and nonresidents over households and institutional investors.
A comparison of the "big-bang" liberalization of 1977 with the success of the gradual process of the current liberalization, reveals the reasons for the failure of the first one. Understanding these factors facilitated a more successful process. These factors being: inadequate macroeconomic conditions, the extent of the openness of the local capital markets, the information infrastructure on capital flows, and the extent to which policy tools were adapted to the removal of foreign exchange control.
An examination of the macroeconomic impact of the liberalization process on the Israeli economy reveals numerous indications of increased openness of the economy, an expansion of its financial account (inflows as well as outflows), and an improvement in its financial status. In addition, the growing involvements of nonresident in capital markets, led to more efficient capital markets, and enabled the economy to exploit the advantages of globalization in order to integrate successfully into international markets.
