Even with a low probability, the expected cost is high, due to the high penalty inflicted by globalization. Stabilization is a time consuming process. Therefore it is irresponsible to react excessively to the current observed output gap. In Israel it took the authorities about two and a half years to recognize the need for restrictive fiscal policy and implement it. Enhance the Flexibility of the Exchange Rate Regime Or - How to find a suitable exit policy.
Flexibility is a sine qua non for foreign exchange markets.
The shocks will eventually need to be absorbed. Israel's gradual and automatic widening of the exchange rate band towards full flexibility has proved an optimal exit policy from the Central Bank's official commitment to intervene and has strengthened its policy credibility, and therefore allowed a lower interest rate than would otherwise have been necessary. What matters for export profitability is the real, not the nominal exchange rate. The latter was managed for many years with poor results concerning the real exchange rate. The sharp depreciation in October 1998, being the result of market forces, proved to be much more permanent than administered devaluations in the years of a managed exchange rate.