Karnit Flug: The Israeli economy - a macroeconomic perspective
Main points of a lecture by Dr Karnit Flug, Governor of the Bank of Israel, at the Supreme
Court, Jerusalem, 6 August 2015.
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The Israeli economy is an open economy that is greatly affected by developments abroad.
This is reflected in the growth rates in the economy, which are very much in line with those
abroad. The effect of activity abroad is mainly reflected through international trade, which
affects demand for Israeli exports, both goods and services. Goods exports are in a virtual
standstill, against the background of the virtual standstill in global trade, which declined
slightly in 2013 and recovered slightly during 2014. In contrast, services exports have
performed better than global trade.
The labor market is in good condition. The unemployment rate is very low and this, alongside
the continuing trend in the labor force participation rate, with new participants finding
employment, reflects an increasing trend in the employment rate. The development of real
wages per employee post indicates a moderate increase in recent years, and acceleration in
the past year.
Monetary policy
The Bank of Israel's policy acts to achieve the Bank of Israel's targets as set out in the law.
The main target is achieving price stability, meaning meeting the inflation target, and subject
to that, support for the other economic targets, chiefly growth and employment, and support
for financial stability. In recent months, the inflation rate has been below the target, and in the
past 12 months, prices have declined by 0.4 percent, mainly due to a decline in fuel and
commodities prices. In contrast, one-year forward inflation expectations are at the lower
bound of the target range - 1.0 percent. Since the beginning of the year, the shekel has
appreciated, which has contributed to lower prices, following a number of months of
depreciation in the last few months of 2014. The appreciation also makes it difficult for Israeli
exporters to compete in the global market, and our estimation is that the shekel is
appreciated relative to equilibrium levels. Against the background of these developments -
which are also affected by developments in the global economy - the Bank of Israel lowered
the interest rate to the historically low level of 0.1 percent, and purchased foreign exchange.
The budget and the fiscal aggregates
The government has recently been dealing with the finishing touches of the budget. The
proposed budget for 2015 and 2016, which was approved by the government, includes deficit
targets of 2.9 percent of GDP each year, which are higher than those that are appropriate for
the economy in its current state, with a level of activity close to full potential, high
employment rates, and low unemployment rates by historical perspective. The proposed
deficit targets do not support the continued reduction of the debt to GDP ratio. An
international comparison of the tax burden shows that the tax burden in Israel is lower than
the OECD average, and the share of public expenditure in Israel is smaller than the OECD
average. Since our defense expenditures are much higher than those of other advanced
economies, and the interest expenditures on the debt are relatively high, the civilian
expenditure (excluding defense and interest) obtained is very low. Israel is in next-to-last
place in an international comparison of civilian expenditures. (Civilian expenditures include
public services such as education, healthcare, welfare, and public security, as well as
expenditures on growth engines such as investments in infrastructure that are meant, among
other things, to encourage future growth.)
An issue that has an effect on both the longer-term fiscal area and on the cost of living, is the
outline of agreements being formulated between the interministerial team dealing with the
issue of natural gas development and the gas companies. The Bank of Israel's position is
that under the circumstances created, the new outline provides a reasonable response to the
needs of the economy, particularly for the purpose of speeding up the connection of an
additional natural gas pipeline and the promotion of development of the Leviathan and Karish
and Tanin reservoirs. By the nature of negotiations, the outline does not achieve the ideal
result, but it does contain many advantages for the economy. As such, the Bank of Israel
supports the main points of the outline and progress toward its implementation.
The outline arranges a variety of issues related to the natural gas economy that were subject
to uncertainty, thereby enabling more stable regulation of the natural gas economy, which
will make it easier to advance the financing and development of the reservoirs, and will in the
end enable redundancy of supply and a market structure that is more competitive than is
currently the case. The outline also supports the achievement of the government's target to
enable the realization of export contracts with Egypt and Jordan for both economic and
diplomatic considerations.
Before final approval of the outline, it is important that milestones be set for advancement in
the development of the Leviathan reservoir and connecting it to the Israeli gas economy, and
that decisions be made regarding the measures that will be taken should the pace of
development not be according to agreements. In particular, it is important that if a delay in
development prevents the creation of a more competitive structure than is currently the case
in the natural gas market, alternative steps be defined that will advance the connection of the
gas reservoirs to the Israeli economy in the most rapidly possible manner, alongside a
mechanism that will protect Israeli consumers from monopolistic pricing.