How Israel managed to bring down hyperinflation from 444% in the 1980s (and at what cost)

How Israel managed to bring down hyperinflation from 444% in the 1980s (and at what cost)

In the 1980s, when inflation in Israel was measured in triple digits, a joke had become fashionable when an Israeli was asked which was cheaper, whether to take a bus or a taxi from Tel-Aviv to Jerusalem. Although the price was the same, the correct answer was: “the taxi”. Because, at the end of an hour’s journey, the shekel would be worth much less than at the beginning of the journey.

Since then, Israelis have been in the habit of following the consumer price index (CPI) like Argentines follow soccer results. And perhaps they follow it with much more attention because, in those years, they lived through the nightmare of seeing their salaries and the rest of their income eaten away by rampant hyperinflation, which reached 444% in 1984.

Forty years later, that country seems to inhabit another universe. In 2021 —and despite the political turmoil—, the economy grew by 8.1%, which exceeded all forecasts, while the OECD forecasts a slight contraction for this year, to 4.8%. For the first time since 2008, the budget deficit has been practically nil and the unemployment rate is barely 3.4%.

In July 2022, inflation was 5.2% year-on-year, an increase that specialists explain by the global context, especially due to the increase in the price of energy (+18.3%) and food (+4 ,4%).

But let’s do a little history. After the 1973 war, followed by the rise in oil prices, and especially after the economic liberalization program decided by the first right-wing Likud government, inflation skyrocketed in Israel.

Israel came through after runaway inflation in the 1980s
Israel came through after runaway inflation in the 1980s

“During all those years, most families had seen their standard of living improve thanks to economic and social provisions, which did not increase unemployment. The main factor in inflation was the indexation system, under which the exchange rate, wages, social benefits and taxes automatically followed the evolution of the CPI. In this mechanism, also known as linkage, the entire burden fell on the balance of payments, whose deficit went from 1.1 billion dollars in 1972 to nearly 5 billion in 1985,” explains Jonathan Marie, a professor at the University of paris 13

Like many European countries, the Gross National Product (GNP) grew between 1% and 2%, while spending —both public and private— increased 5% per year. Much of the foreign exchange deficit was covered by insufficient US donations and loans, forcing the country to resort massively to financial markets. It was at that moment that the government decided to look for internal solutions to the problems that, until that moment, had been solved thanks to non-Israeli financing.

new policy

“In July 1985, a new policy was adopted, called Economic Stabilization, which established a 20% devaluation of the currency, authorized a price increase of 20% to 30%, and imposed a considerable reduction in subsidies on food products. (such as bread, milk, meat and oil) and exports. At the same time, certain taxes were increased to reduce the deficit but, above all, indexation was ended, freezing prices. Everything, from items sold in stores, to services, contracts, salaries, public budgets and even exchange rates, were fixed at the value of the day the new policy came into force. The workers received a 14% salary increase in one go, to compensate for the rise in prices, and the Central Bank was ordered to execute an extremely restrictive policy, so that the global level of credit would not be modified”, he lists. Sebastien Charles, doctor in political economy.

Four months later, at the end of October 1985, the greatest achievement had been the reduction in public spending. The budget deficit, which represented 16% of GNP the previous year, had fallen by half. Inflation, for its part, was reduced between 10% and 20% per month to 3% or 4%. A few months later, the government began to lift the freeze on some prices.

The stabilization policy won the respect of the world and continues to be studied in all economics faculties, as well as the so-called “coupling mechanism”, and the severe criticism with which the policy was received at the beginning, ended up being transformed into general admiration. .

“Inflation continued to decline throughout the 1990s, although not linearly. The Israeli government decided to reduce the deficit and liberalize the market. Many restrictions on imports were lifted and monopolies were dismantled, which helped lower prices. The Bank of Israel, for its part, adopted a restrictive monetary policy and raised interest rates to sometimes punitive levels”, admits Marie.

In 1996 the economy entered a recession and growth slowed considerably, while unemployment rose to almost double digits. But in 1999 inflation was just 1.3%, the lowest in three decades.

Israeli Prime Minister Yair Lapid
Israeli Prime Minister Yair Lapid

But the social cost was high. And many economists continue to question whether the price Israel paid to end inflation was worth it. “Growth at a standstill, hundreds of companies going bankrupt, tens of thousands of people out of work… Many countries, including the United States, had to ask themselves the same question,” analyzes Charles.

Fortunately for Israel, the battle against inflation came at a propitious time, when other factors helped temper its worst effects. Nearly a million immigrants —mainly from the USSR— arrived in the 1990s, creating new demands and increasing the workforce with trained professionals. The country’s high-tech industry also boomed, creating thousands of jobs and new ventures, while the Middle East peace process opened new doors for Israeli exports.

This year, Israel turned 74 years old and its leaders agree that probably the best word that defines the country’s economy is “resilience”. It is true that, despite the country’s chronic political instability, its economy weathered the 2008 financial crisis far better than the rest of the world, thanks to its budget and monetary policies, its current account surplus, its high foreign exchange reserves and a solid banking system. It is an economy that, moreover, was able to quickly overcome the worst recession caused by the Covid-19 pandemic, thanks to its growing technology industry.

“We could say that it is a structural feature of the Israeli economy. Every time there is a crisis, the country manages to get through it better than other advanced economies,” says Victor Bahar, chief economist at Bank Hapoalim, referring to the new challenge posed by the war in Ukraine, the energy crisis and the global inflation stampede.

In his opinion, “the legacy of the economic crisis and hyperinflation of the 1980s continues to play a role in the minds of political leaders, as well as in that of citizens.”

Melissa Galbraith
Melissa Galbraith is the World News reporter for Globe Live Media. She covers all the major events happening around the World. From Europe to Americas, from Asia to Antarctica, Melissa covers it all. Never miss another Major World Event by bookmarking her author page right here.