Macroeconomic review by Governor of the Bank of Israel to the Knesset Finance Committee

While Israel’s economy is in a relatively strong position, mainly due to the policy pursued by the different governments in the last few years, we cannot expect to avoid a slowdown in growth as a result of the developments in the European economies.

(Communicated by the Office of the Spokesperson and Economic Information, Bank of Israel)
Prof. Stanley Fischer: I would like to begin with the bottom line: Israel’s economy is in a relatively strong position, mainly due to the policy pursued by the different governments in the last few years. If we conduct our affairs responsibly we will come through the coming period relatively well, without a recession, although we cannot expect to avoid a slowdown in growth as a result of the developments in the European economies.
A high level of uncertainty still prevails around the world. Although US unemployment has declined, some of that is due to the fact that some of the unemployed have stopped looking for work; nevertheless, the decline is a positive move in the right direction. The rate of growth in China has slowed. The situation in Europe is serious, with low or even negative growth rates, and very high unemployment rates in some countries. The position in Europe is reflected by the yields on government bonds, with extreme increases in countries experiencing debt crises. Such high interest rates, combined with high debt levels, make the burden of financing the debt unbearable. In Israel the yields on government bonds, fortunately, is reasonable.
The main question is, therefore, what will happen in Europe? Agreement was reached recently on limiting the fiscal independence of the eurozone countries. Every few days meetings are held that seem to be promising, but in the last few weeks we have been disappointed to discover that after each meeting the hopes of achieving a sustainable arrangement dissipated. These meetings will continue, in the hope that an arrangement will be reached, and it is to be hoped that the final scenario will not be the dissolution of the eurozone. We do not know what would happen if such a scenario would became a reality, but we do know that there would be economic chaos. We are trying to prepare ourselves for such an eventuality, but there is great uncertainty as to how it would occur or if it will occur. Be that as it may, even if the eurozone continues in its current format, we expect that economic activity in Israel will suffer a negative impact due to the decline in economic activity in Europe.
Israel’s economy is exhibiting signs pointing in both directions: unemployment is low, building starts are at a high level, and data for the third quarter show a high rate of investment. Exports are slowing, however, although the depreciation of the shekel since July is expected to help export growth. Tax revenues are lower than expected, and consumption is increasing slowly, so that since the second quarter of 2011 GDP has grown at an annual rate of 3-3.5 percent.
The OECD recently published an updated growth forecast for Israel, according to which GDP will increase by 2.9 percent in 2012. The Bank of Israel’s latest forecast, compiled in September, is for growth of 3.2 percent. This forecast is due to be updated in the near future, to around the level of the OECD forecast.

The government deficit is expected to be 3.5 percent of GDP this year, slightly above the target. If the government were to continue with its planned tax cuts, the deficit would rise in the next few years, and would approach 5 percent of GDP, and the debt/GDP ratio would increase to more than 80 percent, compared with a level of 75 percent this year.

In the current global economic situation an upward trend in the debt/GDP ratio is highly undesirable. As of today, based on the current budget path, the debt/GDP ratio is expected to remain at around its current level. The government will have to make decisions, but my view is that we should set ambitious targets for fiscal policy in order to return to a downward path for the debt/GDP ratio.
This week the Bank of Israel showed that the defense budget hardly deviated from the Brodet framework. The government is obliged to protect its citizens, and if in the changed priorities an increase in the defense budget is required, it is important that this be done without increasing the deficit, i.e., it should be at the expense of other expenditure or via increasing tax rates.
With regard to the appropriate policy in light of the challenges facing us, we must continue to strengthen the economy and avoid taking populist steps, which appear popular in the short term but incur high long-term costs. Monetary policy can react as necessary, and the Ministry of Finance also prepared plans during the last crisis, which can be activated if and when necessary.