Small Open Economy New Keynesian Phillips Curve : Derivation and Application to Israel

A New Keynesian Phillips Curve is derived for a small open economy with the characteristics of the Israeli economy: price indexation to inflation of the Consumer Price Index and to depreciation of the Shekel against the US$. Estimation is then carried out, in order to study the inflation dynamic in Israel under the inflation targeting regime from 1995 to 2006. The main results show that the openness of small economy in general, and the characteristics of the Israeli economy in particular, induce significant channels of influence from the exchange rate in the transmission mechanism of the monetary policy