BANK OF ISRAEL
Office of the Spokesperson and Economic Information
July 29, 2015
Press Release
Research: Through what channels does the exchange rate impact on inflation?
 Imported goods and services make up 27.5 percent of the consumption basket
used to calculate the Consumer Price Index (CPI)—16.6 percent of the basket is
made up of imported final products and 10.9 percent is made up of imported
production inputs.
 The share of the tradable component of the CPI in the overall index is around 35
percent, and—as it is calculated in the research—serves as an estimate of the
total impact of the exchange rate on the CPI (the transmission from the
exchange rate to the CPI).
 The share of imported components varies between industries. For example, their
share in the clothing industry is 87 percent, while it is 32 percent in the food
industry. The per-industry data may, for example, help to understand how
imposing customs duties affects different industries.
 The calculations noted are carried out in Israel for the first time, made possible
by the adoption of a unique methodology. This method is based on input-output
tables and aligning them with the CPI components.
New research by Dana Orfaig of the Bank of Israel Research Department examines the
transmission from the exchange rate to the Consumer Price Index (CPI) through a precise
calculation of the tradable component in the various industries and its contribution to the
overall CPI. The method used in the research allows the calculation, for the first time in
Israel, of the share of the imported component of the CPI. The study’s findings indicate
Bank of Israel - Research-Exchange rate impact on inflation (Dana Orfaig 2015)
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that the share is 27.5 percent, of which 16.6 percent is made up of final products and 10.9
percent are made up of imported production inputs. As Table 1 shows, the methodology
developed in the current research also allows the calculation of those shares in the various
industries. To illustrate, the share of imported products in the clothing industry is 87
percent, and in the food industry it is 32 percent.
The exchange rate does not only impact on prices of imported products in the CPI but
also on other products that can be traded between countries, including items that are not
imported but that serve as substitutes for imported products, and items that are sold to the
domestic market but that can be exported. Such products, together with the imported
products, form the tradable component of the CPI, and according to the research its share
in the overall CPI is around 35 percent. The share of the CPI’s tradable component, as
calculated in the research, serves as an estimate of the extent of the transmission from the
exchange rate to the CPI—assuming that in the long term there is full transmission from
the exchange rate to the prices of tradable products.
The research calculates the share of the tradable component with a high level of precision
relative to previous research. The calculation method takes into account that each product
in the final consumption basket is made up of a tradable component and a nontradable
component—the price of an imported product incorporates domestic components, such as
marketing and storage, and the price of a domestically produced item incorporates
imported production inputs. The research makes use of detailed quantitative data from
input-output tables published by the Central Bureau of Statistics. The tables provide
information on the production inputs and the various uses of 159 industries. Those
industries were classified in the current research into CPI components. This method is
different from those used in previous research, among other things because those studies
analyze the transmission by estimating inflation equations, or alternatively by dividing
the CPI into tradable and nontradable components through a method that is not based on
quantitative data.
Bank of Israel - Research-Exchange rate impact on inflation (Dana Orfaig 2015)
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The research may contribute to the formulation of monetary and fiscal policy. For
monetary policy, which primarily aims to maintain the inflation target, there is
considerable importance to a fundamental and structural understanding of the manner in
which monetary policy impacts on inflation through the exchange rate. In addition, the
research allows analysis of the sources of inflation, due to the precise distinction between
its domestic component and its external component (which is affected by foreign factors).
With regard to fiscal policy, the per-industry data will be able to assist in understanding
how imposing customs duties impacts each industry.
Table 1
The share of the tradable component and its constituent parts in industries 1
Agricultural output
Food, drink, and
tobacco
Wood and wood
products
Clothing and textile
products
Footwear and leather,
rubber and plastic
products
Chemical products and
petroleum products
Metal products,
machinery, transport
equipment and
electrical items
Imported
final products
Imported
production
inputs
Total imported
component of
industry
Import
substitutes
Goods that can
be exported
Total tradable
component of
industry
Industry’s
share in
overall CPI
Contribution of
tradable component in
industry to overall CPI
6
5
11
5
14
27
3
0.8
16
19
32
6
0
36
12
4.3
30
30
51
4
0
53
1
0.7
79
40
87
100
79
100
3
2.9
87
35
92
100
25
100
1
1.4
47
52
75
39
51
92
7
6.5
69
29
78
71
79
99
7
6.5
Various industries
Construction and
housing services
38
65
78
20
71
95
2
2.2
1
4
5
2
0
7
25
1.8
Water and electricity
Communications,
travel, etc.
0
22
22
0
0
22
4
0.8
12
21
30
21
25
59
9
5.0
Taxes and insurance
3
9
12
0
0
12
6
0.7
Public services
3
7
10
0
0
10
9
0.9
Personal services
0
3
3
0
0
3
7
0.2
Hospitality services
0
4
4
0
0
4
3
0.1
Business services
Total shares of the
tradable component in
overall CPI
1
7
8
0
7
15
1
0.2
35.10
1
The figures in each row are not combined using simple addition. The specific method used is discussed in
the research paper itself.
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