Chapter 1 - The Economy and Economic Policy


Chapter 1
·         GDP grew by 2.8 percent in 2014. Net of the effects of the start of natural gas production from the Tamar field and of Operation Protective Edge on activity, growth has been stable in the past three years at a relatively low rate of 2.5–3 percent. The continuation of the slowdown of growth in the vast majority of advanced economies is the main factor in the moderation of domestic growth in recent years. This slowdown affects the Israeli economy primarily through declines in demand for exports and in demand for domestic investment.
·         Inflation in 2014 was –0.2 percent, below the lower bound of the inflation target range. It included the moderation of increases in prices of nontradable goods due to domestic supply factors, a sharp decline in oil prices, and continued declines in the prices of other tradable goods.
·         The main challenge faced by monetary policy in 2014 was to return inflation to within its target range, support real activity, and mitigate the forces for appreciation of the shekel while minimizing economic risks—as the monetary interest rate reached to near zero. This challenge is now common to many central banks. Some have lowered their monetary interest rates to negative levels, and several have used other tools in support of intensified monetary accommodation.
·         In the past two years, fiscal policy has managed to reduce the structural deficit by raising tax rates (in 2013) and keeping within the expenditure ceiling. In 2014, the general government deficit was 2.6 percent of GDP and the central government deficit was 2.8 percent, consistent with the original budget program despite a steep increase in defense expenditure.
·         Notwithstanding the relatively low growth of real activity and the reduction of the structural budget deficit, the unemployment rate continued to fall. This is credited to the flexibility of the labor market, manifested in 2014 by fewer hours worked per employed person and only a moderate increase in real wages even as inflation surprised to the downside.
·         The trend of appreciation in the nominal effective exchange rate that began in 2008 continued in the first half of the year. In the second half, the shekel depreciated due to the reduction of the interest rate, the narrowing of the spreads between Israel’s rate and those of the ECB and the Federal Reserve, appreciation of the dollar around the world, and continued purchases of foreign exchange by the Bank of Israel.
·         Home prices and rents continued to rise. The stock of new homes for sale increased, affected by the wait for the Zero VAT program. Building starts remained stable at a high level and total activity in the construction industry moderated slightly as the year progressed.
·         The balance of credit to the business sector remained virtually unchanged in 2014, continuing the trend of the past three years. In contrast, the balance of household credit increased at a relatively high rate, marking a continuation of the reallocation of credit in the economy—some of which is structural.
·         The discussion of the cost of living at the end of this chapter illustrates the concept’s complexity. The findings indicate the possibility of a small upward deviation in the domestic price level. However, the upward deviation is significant in some industries, mainly due to natural and regulatory barriers that dampen competition.
The Economy and Economic Policy           
PDF file