Recent Economic Developments

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  •       Economic activity continued to grow in recent months at a rate similar to that which prevailed over the past three years, with a rapid rate of growth in private consumption, a virtual standstill in exports, and a decline in investment. The unemployment rate continued to decline, and the labor market participation rate stabilized at an elevated level.
  •       Through November 2015, the government is operating with an interim budget. Expenditures so far are similar to the path consistent with the statutory expenditure ceiling. The deficit expected in 2015, of 2.5-2.8 percent of GDP, is similar to the statutory deficit ceiling.
  •       The new government’s guidelines include programs with a marked budgetary cost whose sources of funding are not detailed.
  •       The expected deficit in 2016—based on expenditure programs approved by the government and those included in its guidelines, and given current tax rates—is around 3.3 percent of GDP, and in 2017–20 it is around 3.5 percent of GDP, significantly above the deficit target.
  •       The government’s planned expenditures, based on approved programs, including those incorporated in its guidelines, are about NIS 10 billion greater than the expenditure ceiling for 2016 and about NIS 14 billion greater than the 2020 ceiling. This assumes that from now until 2020 the government does not decide on a single additional expenditure without offsetting another expense by the same amount.
  •       In light of the considerable adjustments required to meet the existing fiscal targets, the government should examine if those targets are appropriate for its order of priorities, and if it assesses that will be able to meet them.
  •       With that, in order to maintain fiscal credibility, it is important that the deficit target that is adopted does not exceed 2.5 percent of GDP, to assure a continued decline, even if moderate, in the debt to GDP ratio.
  •       In addition, the government has to decide whether to continue to reduce the share of its expenses in GDP in line with the existing expenditure rule, even though this share is low compared with other advanced economies, or to raise the ceiling and increase revenue in parallel, subject to the target of a measured decline in the debt to GDP ratio.
  •       If expenditures and revenues continue as currently planned, the debt to GDP ratio is expected to rise to over 70 percent by 2020.
  •       In order to avoid repeated adjustments in expenses, due to gaps between expected and actual inflation, the government should switch to nominal budgeting, based on the midpoint of the inflation target range.
  •       It is important that the budget fully and transparently present—in line with generally accepted accounting principles—its expenses for dealing with expanding housing supply, including handling the vacating of lands in the central areas of the country. To the extent that one-off expenditures are required for those objectives, it is preferable that they are recorded as an extraordinary addition to budgetary expenditure and the deficit in accordance with generally accepted accounting principles, and not through extra-budgetary items.
The Bank of Israel is publishing today its survey of Recent Economic Developments, which includes its periodic fiscal survey and drill-down analyses of several economic topics. The survey indicates that since October 2014, the economy has continued to grow at the rate of the past three years, on average, but there was marked volatility during the period, reflecting shocks such as the recovery from Operation Protective Edge, the effect of changes in taxation on vehicle imports (and its effect on reported output), and fluctuations in exports. Private consumption led the increase in demand in the economy during the period, while exports and investment increased at the end of 2014 but declined in the beginning of 2015. In the labor market, the unemployment rate continued to decline and the participation and employment rates stabilized at elevated levels.
In the fiscal survey, the Research Department analyzes the expected development of government expenditures, its revenues, the state budget deficit, and the debt to GDP ratio, based on the government’s budget decisions, including those incorporated in the new government’s underlying guidelines. The analysis indicates that in 2015, when the government is operating on the basis of an interim budget, the deficit is forecast to total 2.5–2.8 percent of GDP, with expenditures similar to the ceiling set by the fiscal rule. In contrast, in 2016, the level of expenditure is expected to be NIS 10 billion greater than the ceiling, and the projected deficit—assuming that no steps are taken to increase government revenue—of 3.3 percent of GDP is markedly larger than the target set by law (Figure 1). A significant part of the gap between the fiscal aggregates and their targets reflects new decisions reached by the government when it was being formed, while it did not at the same time point to sources for funding them. Examining expected developments in 2017–20 indicates that without adjusting steps, the deficit is expected to stabilize at a level of around 3.5 percent of GDP, and the debt to GDP ratio is to increase to over 70 percent by the end of the decade. This assumes that through 2020 the government does not make any new decisions that involve increasing its expenditures or reducing its revenues.
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Source: Based on budget data and BOI projections.
The Bank of Israel notes that in light of the size of the adjustments required to achieve the existing fiscal targets, the government should examine if these targets are in line with its order of priorities, and if it assesses that it will be able to meet them. The Bank emphasizes that in order to maintain fiscal credibility, it is important that the deficit target that is set does not exceed 2.5 percent of GDP, in order to allow an extended decline, even if moderate, in the debt to GDP ratio. Based on past experience, and given the economy’s stage in the business cycle, the government should not set a greater deficit for the coming year together with a framework of future declining deficits, particularly if this framework does not incorporate legislation in advance regarding the specific measures that will ensure the decline (and not just a decision on a general path of steps or reduction in expenditure level). In addition, the government should decide whether to continue to reduce the share of its expenditures in GDP in accordance with the existing expenditure rule, even though this share is low compared with other advanced economies, or to raise the ceiling and in parallel increase its revenues, subject to the target of measured reductions in the debt to GDP ratio.
The size of the State’s budget is in adjusted each year by the difference between actual and forecast inflation. In some years, the size of the adjustment is significant and impacts on real activity in the budget, because the prices that are relevant to government expenditures do not change, in the short term, in line with the CPI. As a result, there are repeated adjustments to government activities, and after a short period of time they need to be corrected with an adjustment in the opposite direction. Since in the past 15 years the rate of inflation in Israel has been around 2 percent—the midpoint of the inflation target range—there should be a move to a nominal budget, based each year on a price increase of 2 percent, without adjustments for deviations from the forecast, other than for prolonged or extreme deviations.
A main target that the new government set for its activities is reducing home prices and expanding supply, and already at its outset it has adopted significant measures that are intended to expedite the planning processes and to moderate prices. Some of the issues holding back progress in planning and construction may be resolved though reallocating budget resources to construction of supporting infrastructures, reducing obstacles, and moving government and public facilities from areas in high demand. The government has already approved some such plans, and their implementation is likely to require a marked amount of increased expenditure. It is important that the government account for this when formulating the coming budget, and insert these expenditures into its expenditure path for the following years, in order to prevent delays in implementing the plans. It is also important that the government budget fully and transparently reflect its expenditures for dealing with expanding housing supply in accordance with generally accepted accounting principles. The proper accounting for government activities to promote construction does not mean it has to avoid those activities, and is intended to maintain the transparency of the costs involved in government activities. To the extent that one-off expenditures are required for this goal, it is preferable that they are recorded as an extraordinary addition to budgetary expenditure and the deficit in accordance with generally accepted accounting principles, and not through extra-budgetary items.
In addition to the current survey and the fiscal survey, Recent Economic Developments includes drill down analyses on four topics, three of which were published in the past two weeks: the effect of quality of education on the growth of Israel’s economy, the effect of the mandatory pension arrangement on the wages of employees who were required to begin saving for retirement; and an examination of the considerations in restarting the plan to scrap old cars. The fourth subject deals with the development of inflation expectations in the past year and the potential deviations in measuring expectations. The discussion focuses on the decline in long term inflation expectations over the past year in Europe and the US, while it occurred to a lesser extent in Israel and the UK. Although the deviation of long term expectations is liable to indicate a negative impact on the credibility of the price stability target, there are indicators that point to the current decline being explained mainly by changes in the inflation and liquidity risk premiums, and not necessarily in inflation expectations themselves.