stanley fischer : overview and challenges facing the israeli economy speech by professor stanley fischer, governor of the bank of israel, at the seventh annual herzliya conference, herzliya, 23 january 2007. * * * as you surely know, the israeli economy is in very good shape. according to initial estimates by the central bureau of statistics, gdp grew in 2006 by 5 percent, which seems all the more impressive as it was a year with hostilities in the north. furthermore, we saw rises in investment, exports, employment, and productivity, while unemployment continued to fall, reaching 8. 3 percent, compared to a record high of 10. 7 percent in 2003. the lowest unemployment rate the economy achieved since 1990 was 6. 6 percent. that was in 1996, when the labor market was at the start of structural change with the entry of foreign workers, and it is therefore reasonable to assume that the natural rate of unemployment – that commensurate with full employment – is now at a higher level. at the same time, financial stability and price stability have been maintained. this background allowed for cumulative interest rate cuts in recent months such that now, for the first time, there is a significant negative interest rate gap of 0. 75 percentage points, between the bank of israel and the us fed rates. these achievements are beginning to give us encouraging signs regarding certain improvements in two problematic areas that the economy faces : • the public sector debt burden. this, one of the biggest problems in the israeli economy, fell to about 88 percent of gdp compared to 97 percent at the end of 2005. this is a remarkable achievement, but it is important that we continue along this path to bring the ratio down to 60 percent of gdp – the ceiling set by the maastricht treaty – and after that, to bring the ratio down even further. • poverty, a major topic of public debate in israel. the bank of israel monitors not only relative poverty – a measure principally of social gaps – but also a measure of absolute poverty. this is a measure of the individual's ability to purchase a basket of essential goods. we have therefore been closely following developments of a measure of the poverty line, calculated in real terms since our base year ( which we've taken as 1997 for calculation purposes ). from our analyses, we see that in 2005 there was some drop in absolute poverty after it had risen in the years 2001 to 2004. those years where the absolute poverty index rose could be attributed to

effectiveness of the system, to direct sufficient resources to it and to ensure equal opportunities for children from all strata of society in order to encourage and nurture excellence. education is a very important issue that will aid economic growth in the long term as well as reduce social gaps. in israel, as elsewhere, the yield on education has increased a great deal in recent years. 3. banking competition : the bachar committee achieved its mission of increasing competition in the credit field, but now we face the challenge of boosting competition in the retail field. here, the supervisor of banks is the major player, and together with the management of the bank of israel and me, is examining ways to strengthen competition in the banking system including making it easier to transfer accounts from one bank to another, and more besides. there is the field of bank charges, and in this context the bank of israel has already prepared a bill that would grant the supervisor of banks the authority to regulate fees in areas that have no competition. this bill will be submitted in the next few days. 4. in infrastructure : in this context i refer to the fields of transportation – roads, rail, public transport – and the field of electricity – and here it is important to carry out the planned reforms. 5. real estate : here our emphasis is mainly on developing a more efficient real estate market, on land ownership ( the israel lands administration ) and on easing the bureaucratic processes such as planning, licensing and registration. reform in this field is clearly not a simple matter but it is important to begin freeing the real estate market in israel from its many current restrictions. 6. defense spending : this is very much on the agenda of the day, and i am happy to see that a committee headed by former director general of the ministry of finance, david brodet, is dealing with this subject, and the bank of israel is involved. clearly every country has the responsibility of defending its citizens, but it is difficult to know exactly what resources are required. it is easy to err in either underestimating or overestimating the funds needed. so it is important to establish from time to time a select group of professionals, such as the current committee, to check this matter thoroughly, and it is important too to follow through on any resulting recommendations. 7. health : this subject often pops up on the agenda and, among other things, it is important to examine the pricing of various health services. i would like to add here that overall the