Chapter 1 - The Economy and Economic Policy

04/04/2013

Summary:

  • In 2012, economic growth slowed to 3.1 percent, inflation was 1.6 percent, the current account was close to balance, the unemployment rate remained stable at its lowest level in the past 30 years, and the government deficit widened to 4.2 percent of GDP.

  • GDP growth slowed in line with a slowdown in global growth, an increase in expenditure on import of energy products, and a moderation in growth in the construction industry.

  • Monetary policy supported economic activity, through measured reductions in the Bank of Israel interest rate, continuing the reduction in the second half of 2011.

  • The decline in tax revenues as a percent of GDP led to an increase in the government deficit beyond the target. The government first allowed the “automatic stabilizers” to operate, but with the widening of the deficit, decided to increase taxes. The structural deficit, which remained large and limited the government’s ability to deal with crises in the future, as well as the increase in budget commitments beyond the expenditure rule, present a challenge to fiscal policy.

  • The increase in home prices resumed during the second half of 2012, and for the entire year, home prices increased by 5 percent in real terms. The number of transactions and housing credit both grew significantly, and activity, employment and wages in the construction sector continued to grow, though there was some slowdown in building starts. These developments were affected by the multiyear shortage in homes relative to population needs, limitations in issuing building permits which negatively impacted the supply of homes, as well as the decline in interest rates and alternative yields, which supported demand for homes both for residential purposes and as investment assets.

  • In 2012, share prices increased slightly, relative to their increases worldwide. Yields on Israeli government bonds continued to decline during the year, and reached a historic low, but at the same time there was an increase in the yield spreads versus similar bonds of other advanced economies.

  • Two risks left their mark this year on developments in the Israeli economy: the global economic risk, which resulted mainly from the debt crisis experienced by many countries in the world, particularly in Europe; and Israel’s domestic risk, which resulted from geopolitical developments.

  • The economy’s relatively good macroeconomic situation enables the country to begin dealing with structural problems, such as: (a) the government’s large structural deficit and the increase in commitments to expenditures beyond those allowed by the expenditure rule require an immediate cut in expenditure and/or increased tax revenues; (b) labor productivity in Israel, which is low compared to the average for OECD countries, can be increased by improving educational and physical infrastructure, improving the business environment, reducing the burden of bureaucracy, and increasing competition in the economy; (c) the need to reduce the cost of living, which led in 2011 to the social issues protest, and (d) the need to continue to reduce inequality.


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