stanley fischer : issues of fiscal policy summary of remarks by professor stanley fischer, governor of the bank of israel, at the bank of israel research department ’ s annual seminar, jerusalem, 27 december 2012. * * * the area of taxation in particular, and the fiscal area in general, are in my view among the most interesting areas, and among the areas where theory can contribute the most to delineating policy. my lecture will deal more with macroeconomics, where theory is perhaps less deep but still very important. so what is the starting point for the economy heading into the upcoming period? from the standpoint of growth, we are in a relatively good position. the average growth rate over the past few years has been about 3. 7 percent. currently we are growing at a rate lower than that, if we don ’ t take into account the expected effect that the start of natural gas production will have on growth. the israeli economy grew at an impressive rate in the years prior to the crisis, and the recession during the global crisis was relatively moderate. the unemployment rate is relatively low, even though we are still having difficulties interpreting the new labour force survey data. long - term interest rates are low, and the yields on ten - year government bonds are under 4 percent, and are continuing to decline despite the problems the economy is facing. in the fiscal area, there has been a continued decline in government expenditure as a percentage of gdp since the start of the program led by prime minister sharon and finance minister netanyahu that began in 2003. the rule that determined that expenditures shall not grow by more than 1 percent in real terms is to a large extent responsible for this trend. another factor is the defense budget, which reached 35 percent of gdp after the yom kippur war, was 20 percent of gdp prior to the stabilization plan, and has been in constant decline since then, other than during the second intifada. we currently have a defense burden of about 6. 5 percent of gdp, lower than the ratio that existed, for instance, in the united states during the korean war. government revenues also declined in relation to gdp in recent years, reaching 38 percent of gdp in 2011. this is mainly the result of the reduction in direct statutory tax rates, which has led to a change in the tax mix. in 2003, the deficit was slightly greater than 6 percent of gdp, but the cyclically adjusted deficit was about 3. 5 percent. however, today, the deficit

rate tool, which has reached a very low level. the bank of israel has for the past few years been pursuing a policy of involvement in the foreign exchange market in cases of excessive volatility in the exchange rate that is not in line with the fundamental economic conditions. the bank also purchases foreign exchange in order to offset appreciation pressures derived from market overshooting in reaction to the production of natural gas. it is important to note that our foreign exchange policy takes the long - term economic forces into account, and we are acting to give the business sector time to adjust to the trends derived from these forces. in order to deal with the risks derived from growth in the balance of housing credit, the bank of israel has for a number of years been placing various limitations on the mortgage market. these are prudential tools that reduce the risk both to the financial system and to borrowers. a few words on the long term. over time, we see very slow growth in the rate of productivity, and in parallel to growth, we were seeing growth in poverty and in inequality. the main challenge facing the israeli economy over the long term is to succeed in creating inclusive growth. i would like to explain what i am referring to by this term. i am referring to continued, sustainable growth whose results will be divided more equally among all parts of the population, such that they will support a higher standard of living for all sectors, and a reduction of poverty and inequality in the distribution of income. inclusive growth cannot be driven by a narrow growth engine. it must be broad based over a variety of industries, so that it can provide employment to all parts of the population over time. these include, for instance, small and medium businesses, tourism, and low technology industries – industries that can provide employment and income to workers at all skill levels. such growth, in the center of the country and in the periphery, will ensure that the labor market is able to also absorb those who join it from the sectors with relatively low human capital or with employment levels that are still low. the challenge in creating inclusive growth is immense. it is a goal that many countries are grappling with, and it is not easy to achieve. it is important that, in formulating its strategic plan for the coming years, the government focus its policy such that we progress in this direction. inclusive growth will contribute to strengthening the cohesiveness among various population groups and within the groups themselves. bis central bankers ’ speeches