Abstract
This document presents the macroeconomic staff forecast formulated by
the Bank of Israel Research Department in January 2021 concerning the main
macroeconomic variables—GDP, inflation, and the interest rate. The forecast
includes two main scenarios: a scenario that includes a process of rapid
inoculation of the population that lasts until May 2021 (hereinafter the rapid
inoculation scenario), and a scenario that includes a more prolonged
inoculation process lasting until June 2022 (the slow inoculation scenario). Following the date of full inoculation in
either of the scenarios, there would be no government restrictions with
significant impact on economic activity. As of now, in view of the rapid pace
of inoculations over the past two weeks, it seems that the rapid scenario is significantly
more likely than the slow scenario.
In the rapid inoculation scenario, GDP is expected to expand by 6.3
percent in 2021 and by 5.8 percent in 2022.
Inflation in the coming four quarters (ending in the fourth quarter
of 2021) is expected to be 0.6 percent, and inflation in 2022 is expected to be
0.9 percent. The broad unemployment rate among those
aged 15 and up is expected to decline to 7.7 percent of the labor force by the
fourth quarter of 2020, and to continue to decline gradually to 5.4 percent at
the end of 2022. The government deficit
is expected to be 8 percent of GDP in 2021 and 3.6 percent of GDP in 2022, such
that the debt to GDP ratio is expected to be 77 percent in 2021 and 75 percent
in 2022. This is all under the
assumption that the government carries out policy measures (lowering
expenditures and increasing taxes) on a scale that is in line with the
restraint derived from the legally mandated expenditure ceiling. Without such an adjustment, expenditures
based on existing decisions will lead to a deficit of about 4 percent of GDP in
2022.
In the slow inoculation scenario, GDP is expected to expand by 3.5
percent in 2021 and by 6 percent in 2022. Inflation in the coming four quarters (ending
in the fourth quarter of 2021) is expected to be 0.1 percent, and inflation in
2022 is expected to be 0.8 percent. The broad
unemployment rate (aged 15+) is expected to decline to 11 percent by the fourth
quarter of 2021, and to continue declining to 7 percent at the end of 2022. The government deficit is expected to be about
11 percent of GDP in 2021 and 6 percent of GDP in 2022, such that the debt to
GDP ratio will be 82 percent in each of these two years.
The Forecast
In this forecast, as in the recent forecasts published, special emphasis
is placed on an analysis of the volume of activity in the economy as a result
of government restrictions to fight the spread of the virus. In addition, the forecast
contains information from various other indicators and models. The Bank’s DSGE
(Dynamic Stochastic General Equilibrium) model developed in the Research
Department—a structural model based on microeconomic foundations—which provides
a framework for analyzing the forces that have an effect on the economy, was
used to combine them into a macroeconomic forecast of real and nominal
variables.
a.
The global environment
Our assessments of expected developments in the global economy are based
mainly on projections by international institutions (the International Monetary
Fund and the OECD) and by foreign investment houses. Accordingly, our
assumption is that GDP growth in the advanced economies will be 3.4 percent in
2021, compared with 5.7 percent in the October forecast, and 3.4 percent in
2022 as well. Based on the OECD
forecast, world trade is expected to grow by 4 percent in 2021, 3 percentage
points lower than our previous forecast, and by 4.5 percent in 2022. Inflation in the advanced economies is
expected to be 1.4 percent in 2021—0.5 percentage points higher than in the
previous forecast—and 1.6 percent in 2022.
The average interest rate of the central banks is expected to remain at
0.1 until the end of 2022, unchanged from the October forecast. Oil prices increased to about $51 per barrel since
the publication of the October forecast.
b.
Real activity in Israel
In both scenarios in the forecast, economic activity in the fourth
quarter of 2020 is identical. Therefore,
in both scenarios, growth for the year in 2020 is expected to be -3.7
percent, and the average level of economic activity is expected to be about
7 percent lower than the GDP trend prior to the crisis. Average broad
unemployment in 2020 is expected to be 15.8 percent (an average of about 16
percent in the fourth quarter). During
the forecast period, our assessment is that in both scenarios, activity will be
higher than we predicted in the October forecast. This is in view of the start
of inoculations before the end of the year—which was earlier than we assumed in
October—and in view of a reassessment of nonactivity rates due to the
restrictions, particularly during the second lockdown when actual activity was
higher than our assumption. This reassessment had a downward impact on our forecast
of the volume of inactivity during the lockdowns that are expected during the
forecast period in both scenarios (see below), and contributed to the increase
in the growth forecast.
In the rapid inoculation scenario, we assume growth of about 6.3
percent in 2021, and about 5.8 percent in 2022.
In this scenario, economic activity will moderate slightly at the
beginning of 2021 with the current onset of restrictions on activity. With the removal of restrictions, there will
be a relatively rapid recovery in activity, which will continue until the end
of the second quarter as a result of the inoculation of the population.
However, due to the impact on business and household income during the lockdowns,
activity will not return to its normal level even when all the restrictions are
removed. A further prolonged process will be necessary, which will last
throughout the forecast period, so that in 2022, the level of activity is
expected to be about 2 percent below the pre-crisis long-term GDP trend. The growth forecast for 2021 is characterized
by a recovery of private consumption, which is expected to grow by 12.5 percent
following an 11 percent contraction in 2020.
A similar recovery is expected on the sources side, as imports are
expected to grow by about 11 percent after contraction of 12 percent in
2020. In 2022, an acceleration is
expected in the growth rate of investments (8.5 percent) as well as in exports
(4.5 percent).
In the slow inoculation scenario, we expect growth of 3.5 percent
in 2021, about 3 percentage points higher than our assessment in the low
control scenario of the October forecast. This significant improvement is
explained by the higher starting point, due to a lower assessment of the
inactivity rate during the second lockdown, as well as the earlier start of the
inoculation process, which reduced a significant portion of the more extreme
risks. However, lockdowns will continue
every few months until mid-2022, due to the prolonged inoculation process,
which will lead to slower growth than in the rapid inoculation process. In 2022, the growth rate is expected to be 6
percent. The pace of growth of the GDP
components in 2021 is lower than in the rapid inoculation scenario, but the
forecast still reflects a slight recovery in activity relative to 2020. For 2022, the pace of growth of the various
components is expected to be higher in view of the expected recovery upon
completion of the inoculation process during the year.
Table 1
Research Department Staff Forecast for 2021–2022
Optimistic scenario and pessimistic scenario
(rates of
change, percent, unless stated otherwise)
|
|
|
Optimistic scenario
|
Pessimistic scenario
|
|
2020
|
Forecast for 2021
|
Forecast for 2022
|
Forecast for 2021
|
Forecast for 2022
|
GDP
|
-3.7
|
6.3
|
5.8
|
3.5
|
6.0
|
Private consumption
|
-11.0
|
12.5
|
8.0
|
7.5
|
10.5
|
Fixed capital formation (excl. ships and aircraft)
|
-7.5
|
3.5
|
8.5
|
-1.5
|
7.5
|
Public consumption (excl. defense imports)
|
3.0
|
6.5
|
-1.0
|
6.5
|
-1.0
|
Exports (excl. diamonds and startups)
|
1.5
|
3.0
|
4.5
|
2.0
|
4.5
|
Civilian imports (excl. diamonds, ships, and
aircraft)
|
-12.0
|
11.0
|
7.5
|
6.5
|
10.5
|
GDP deviation from the precrisis trend
|
-7.0
|
-4.3
|
-1.9
|
-6.8
|
-4.3
|
Broad unemployment rate (15+) (Average for the year)
|
15.8
|
9.6
|
6.2
|
12.5
|
8.5
|
Broad unemployment rate – fourth quarter (15+)
|
16.3
|
7.7
|
5.4
|
11.0
|
7.0
|
Government deficit (percent of GDP)
|
12
|
8
|
3.6–4
|
11
|
6
|
c.
Inflation and interest
rates
In the rapid inoculation scenario, inflation in the next four
quarters (ending in the fourth quarter of 2021) is expected to be 0.6 percent,
and inflation in 2022 is expected to be 0.9 percent (Table 2). In the slow inoculation scenario, inflation
in the next four quarters is expected to be 0.1 percent, and inflation in 2022
is expected to be 0.8 percent.
Our assessment in both scenarios is that the improvement in economic
activity, together with the dissipation of the effect of the appreciation that
has taken place until now, will lead to a moderate increase in inflation during
the forecast period, such that at the end of 2022, inflation is expected to be
close to the lower bound of the inflation target range.
In both scenarios, our assessment is that in one year, the Bank of
Israel interest rate will be in the range of 0–0.1 percent (Table 2), similar
to our assessment in the October forecast.
The low interest rate supports the recovery of demand and the lowering
of financing costs for businesses (insofar as credit will be available to
them), and it is part of the group of tools being used by the Bank of Israel to
deal with the crisis. Should further
monetary accommodation be necessary beyond the monetary interest rate, the Bank
of Israel may expand or accelerate the use of existing or additional monetary
policy tools.
Table 2 shows that the private forecasters’ projections of inflation in
the coming 12 months and inflation expectations derived from the capital market
are within the staff forecast’s range in both scenarios. In regard to the interest rate in one year
(end of 2021), both the forecasters’ projections and expectations derived from
the capital market are also within the Research Department’s forecast range.
Table 2
|
Inflation and interest rate forecasts for the coming year
|
(percent)
|
|
Bank of Israel Research Department
|
Capital marketsa
|
Private forecastersb
|
Inflation ratec
|
0.1–0.6
|
0.4
|
0.5
|
(range of forecasts)
|
|
|
(-0.4–1.3)
|
Interest rated
|
0–0.1
|
0.06
|
0.08
|
(range of forecasts)
|
|
|
(-0.2–0.1)
|
a)
Average expectations following the publication of the November CPI. Inflation expectations are seasonally
adjusted.
b)
The forecasts published in the week following the publication of the November
CPI.
c)
Inflation rate in the coming year. Research Department: in the four quarters
ending in the fourth quarter of 2021.
|
d)
The interest rate one year from now. (Research Department: in the fourth quarter
of 2021.) Expectations derived from the capital market are based on the Telbor
market.
SOURCE:
Bank of Israel.
|
d.
Main risks to the forecast
The Research Department’s staff forecast presents two scenarios that
reflect boundaries between an optimistic rapid inoculation scenario and a
pessimistic slow inoculation scenario. These
scenarios reflect a reasonable, but not absolute, range of the severity of the
economic impact resulting from COVID-19. More optimistic scenarios (such as a
more rapid recovery following the pandemic) and more pessimistic scenarios
(such as serious lockdowns as in the past, a worsening of financial stability,
and others) are certainly possible. The
risks to the forecast are therefore developments that will lead to a more
optimistic scenario than the rapid inoculation scenario or a more pessimistic
scenario than the slow inoculation scenario. Risks in the health field include
a scenario in which mutations of the virus are resilient to the vaccines that
have been developed, and the development of morbidity such that the nature and
number of lockdowns differs from our assessment. In the economic field, there
is uncertainty regarding the economy’s response during the recovery, including
the depth of the “scars” that the crisis will leave on the economy. In the policy field, a risk to the forecast
is present by how the high morbidity from both COVID-19 and the flu will be
dealt with during the remaining winter months.
Lastly, there is an additional risk due to the political uncertainty
that is affecting fiscal policy, particularly the passage of the 2021 budget
and the timing of the passage of the 2022 budget.