Inlfation and Disinlfation by Steps in Israel

Both the inflation and the disinflation processes in Israel appear to have followed a stepwise pattern. In this paper we test statistically the stepwise representation and analyze the different economic nature of the steps during the inflationary era and during the post­-1985 stabilization period. We claim that in the inflationary era the steps were motivated by a quest for temporary stability in an environment of political and economic instability, The shifts to higher steps, in this period, have been associated with balance of payments crises. A major indicator of the unsustainability of the underlying inflationary process was the secular growth of the ratio of the public debt to GDP. By contrast, the disinflation process has been characterized by a declining debt ratio, which probably entailed a downward trend of the underlying inflation rate. Yet the process got stuck on long steps. In our view, this was because the public realized that there is no political and social consensus for bearing the cost associated with reducing inflation from moderate to low levels. A critical mass of favorable shocks was required to reduce inflation to a lower step in 1992, and one may speculate that a similar phenomenon is taking place at present (1997-­98).