Measuring the importance of global factors in determining inflation in Israel

This paper presents evidence that inflation in Israel and many OECD member states was driven largely by global factors during 2009–17. In particular, inflation in Israel was strongly correlated with that in most OECD countries in the review period of January 2009–June 2017. Furthermore, the development of inflation in most OECD countries is captured well using a model that includes two unobserved common factors. The first two factors that explain most of the co-movement in inflation among OECD countries explain roughly 80% of the variance in Israel’s headline as well as core (ie excluding food and energy) inflation rates during the review period. This finding emphasises the broad-based importance of global factors in determining inflation in Israel. We find that the first factor correlates with oil prices and the trade-weighted USD exchange rate index (the DXY), but this alone does not fully explain the strong cross-country correlation – due to the importance of the second factor. These findings emphasise the importance of analysing global inflation developments as a tool for understanding headline inflation in Israel as well as its subcomponents, and may contribute to a better understanding of monetary policy measures taken in the period reviewed.