Good afternoon. I would like to expand on a number of points raised in the analysis of the developments in the Israeli economy in the Bank of Israel Annual Report.

I will begin with the macroeconomic situation. The Israeli economy, which is affected by developments in the global economy, is undergoing a structural change that is characterized by a change in the composition of demand and, as a result, a change in the composition of production. Due to the outbreak of debt crises in individual countries in Europe in 2011 and the significant slowdown in the global growth rate since then, we see that in the past three years, private consumption has become the growth engine of the Israeli economy. There is a dispute among economists as to the permanence of the change we are seeing in the global economy—whether the slowdown in the expansion of world trade is temporary, or whether it reflects a permanent structural change.
The slowdown in global growth and the weakness of world trade have a direct effect on demand for exports. We see that in the past three years, the contribution of exports to Israeli economic growth is near zero, and in the past year it was even negative.  Since 2012, and basically since the outbreak of the European debt crisis and the slowdown in world trade since then, the growth rate of Israeli exports—which is generally higher than the growth rate of world trade—has become lower than it, and even declined in the past year.
The global economy is a system characterized by economic forces operating at all times to return it to equilibrium. Thus, the Israeli economy, which was not directly impacted by the crisis, grew at a higher rate than most of the other advanced economies.  As such, the economy has enjoyed a surplus in the current account, and flows of investment from abroad. As a result, a trend of real appreciation of the shekel developed, which offset the initial advantage of the Israeli economy be weakening its competitiveness. As the Governor noted in her remarks, the objective of monetary policy is to act against those forces in the short term. The Bank of Israel’s interest rate policy and foreign exchange purchases acted to moderate these forces and to enable the economy to reorganize in view of the changes in the global economy, without increasing unemployment as happened in most of the advanced economies. In the past two years, we can see that the trend of real appreciation was halted according to a number of indices. This development is consistent with the closure of the economic advantage that was reflected in the growth of the Israeli economy relative to the growth of other advanced economies.  We can see that in periods in which the Israeli economy overperformed relative to the other advanced economies, there was a real appreciation of the shekel. The extent of this grows smaller as the over performance declines.  With that, it is important to note that the level of the exchange rate is lower than in the past, making it difficult for exports to lead the growth of the Israeli economy.
Monetary and fiscal policy have made it possible for the economy to deal with the global crisis, and to make the structural change that became necessary as a result. We can identify the process that is taking place without crises in the past three years, of expanding employment in the business services and public services sectors, compared with a standstill in employment in the manufacturing industries that are mostly export oriented. The structural change, of diverting demand from exports to private consumption and public consumption, took place with a continued decline in unemployment, reflecting the contribution of policy. We now see a strong labor market reflected in strong demand, as attested to by the job vacancy rate and the low unemployment.  In other words, it is harder and harder for employers to fill positions without offering a proper increase in wages.
I will now focus on the contribution of monetary policy and its transmission mechanism to the cost of credit to industries that are currently expanding. The increase in private consumption, upon which growth in the last three years has been based, is made possible thanks to credit provided to households, among other things.  Access to nonhousing credit by households in Israel is relatively high by international comparison. We can also see that the rate of growth of credit, as a percentage of GDP, increased in the past two years.  Parenthetically, we can also see that starting in 2005, there has been an increase in the volume of consumer credit relative to GDP to the high level (by international comparison) reached in 2010. Some of this can be attributed to the Bachar reform, which directed the banking system’s sources in this direction at the expense of large businesses, and some can apparently be attributed to reforms in the area of pension and long-term savings.
Small and medium businesses are supplying the growing demand, mainly in the area of services.  Here too we can see that credit provided to these businesses by the Israeli banks is increasing (an increase of about 30 percent in two years), and their share of total credit issued by the banks is also increasing. We can also see the acceleration of these processes in the past two years, as growth has come to be based on private consumption.
Monetary accommodation has lowered the cost of credit to small businesses, and led to the expanded supply of credit to them by the banks. We also project a decline in the price of credit compared to the price of credit paid by large corporations. As the segment of credit allocated by the banks to small businesses increases, competition in the field will also increase, as we saw earlier in the area of housing credit.
Another macroeconomic phenomenon that supported economic activity in 2015 was the drop in energy and commodity prices. This was reflected in an extraordinary increase in the ratio between product prices—the prices seen by manufacturers—and the prices paid by consumers. The Consumer Price Index declined, while the Producer Price Index increased. The beneficiaries of this were basically both manufacturers and households: Employee wages—the nominal wage, and even more so the real wage—which is adjusted to purchasing power—increased by about 3 percent, while the cost of labor as viewed by employers declined slightly. Employers benefited from a decline in energy expenses and in financing expenses (as we saw) so that their profitability did not decline despite the increase in wage expenses.
The decline in commodity prices led to a marked improvement in the current account.  The economy saved about $5 billion on oil imports.  By international comparison, the increase in Israel’s current account surplus reflects the decisions of individuals in the economy to save some of the profit they have gained as a result of the decline in energy prices.  It is possible that this decision is a result of the fact that they view this as a temporary phenomenon.
Another interesting phenomenon is that Israeli exporters have managed (on average) to sell their products even with price increases, in contrast to the development of export prices in other advanced economies. Thus, exports were compensated for the decline in profitability resulting from the nominal appreciation of the shekel. The ability to raise prices in the global economy reflects the market power of Israeli exports in a number of markets, particularly in high technology areas. With that, it is possible that this has come at the expense of some decline in sales.
To sum up the macroeconomic situation: Thanks to monetary policy, fiscal policy, and the decline in commodity prices, the economy succeeded in making the structural change forced upon it by the global economy. With that, as the Governor noted in her remarks, the transition to growth based on domestic demand also poses challenges.  The industries supplying domestic demand are industries characterized by relatively low productivity, inter alia because most of them are not exposed to competition like the export industries, where productivity is high. Without improving productivity in these industries, the economy will have difficulty reducing the gap in the standard of living between us and the most advanced economies. And since it is difficult to expect a significant drop in commodity prices every year that will act to raise the real wages of households, increased productivity is a necessary condition for the continued increase in the standard of living of Israeli employees.
In addition to analyzing macroeconomic developments, as in every year we dealt with many interesting issues, some of which have already been released in the past few weeks.  I would like to focus on two issues that have not yet been published.
One interesting issue we dealt with is the extent of the effect of increasing home prices on the labor market. Rising home prices make it difficult for young couples to purchase a home. The restrictions on mortgages imposed on borrowers in order to prevent overindebtedness by purchasers mean that given the increase in home prices, purchasers are being asked to provide increasing amounts for downpayments. This situation makes it difficult mainly for couples who do not own a home. Those upgrading their home benefit from an increase in the value of the property they own, while investors are taking advantage of the low interest rates to increase their real estate investment portfolios.
We therefore examined whether the need for additional initial equity is a cause of the change in the supply of labor by young couples. In other words, does the desire to purchase a home lead to an increase in the volume of labor and an increase in household income? A first glimpse of the phenomenon, from the Household Expenditure Survey and data from the Tax Authority, clearly shows that households that did not own a home increased the volume of their work. The increase was reflected in both the increase in the time spent at work, and in the fact that the number of breadwinners per household increased relative to the number of households that own a home.
A more precise econometric analysis, which controls for the characteristics of breadwinners in the various households, reinforces the phenomenon and brings its various aspects into sharper relief. From the standpoint of labor inputs, which are reflected in the number of work months per year, married couples who own a home reduced their labor inputs, while couples who chose to purchase a home increased their labor inputs. It is interesting that most of the increase in labor inputs came from increased employment of the main breadwinner—generally the husband.
Some of the expansion in employment is explained via young couples’ need to increase their employment in order to finance the purchase of a home. This is made possible due to the strength of the Israeli economy and the policies supporting it.  Thus, indirectly, the strength of the Israeli economy is also contributing to the high real estate prices.
The second issue I would like to discuss is the chapter analyzing the housing and construction market. In this chapter, we dealt with a number of issues, the common denominator among which is the attempt to solve major problems in this market, mainly concerning young couples. Most households are concentrated in the central region of the country, and even more prominently in the Tel Aviv metropolitan area.  The price increases are the highest in this area, since there is a lack of available land for construction.
One of the solutions to the lack of land for construction is increasing the population density through various urban renewal programs, as is common in other major cities in the world. In Israel in general, and in Tel Aviv in particular, incentives were provided for programs as part of National Outline Plan 38, in which the areas of homes in an existing building are increased somewhat, generally in exchange for the addition of one or two floors. And we see that the greatest demand for such programs is in the Tel Aviv and central regions.
In this way, a response is provided in a relatively short time span to the housing distress in the Tel Aviv area. However, a longer-term view, taking in what is happening in large cities around the world, shows that the population increase in Israel’s central metropolitan area can be expected to continue and even to intensify.  From this point of view, a further increase in density of the Tel Aviv area is therefore required. The most appropriate framework for this is urban renewal through a vacate-and-build or build-vacate-and-build program, involving the destruction of existing buildings and significantly increasing the utilization of the land. The structure of incentives currently in place gives preferences to NOP 38 programs, but carrying out such programs in places that are appropriate for vacate-and-build programs blocks the ability to increase density in the Tel Aviv area for many years. We therefore recommend to policy makers dealing with the burning issues of the real estate market to also take into account the possible long-term results as part of their considerations and the solutions they propose.