The Israeli Economy: Maintaining a The Israeli Economy: Maintaining a Thriving Economy in the Shadow of Thriving Economy in the Shadow of

TerrorTerror

Prof. Zvi Eckstein

Deputy Governor, Bank of Israel

The Jerusalem Center for Public Affairs

March 26, 2007

Macroeconomic Picture

Real GDP per CapitaReal GDP per CapitaIsrael vs. USAIsrael vs. USA

Source: BEA, PWT, OECD, BOI

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Israeli GDP per capita, thousands NIS, 2000 (left scale)

Ratio of Israel to USA GDP per capita (right scale)

Running an Economy Under Running an Economy Under TerrorTerror

• In the past years (2000-3) the terror in Israel has become a part of every day life.– A continuous impact on GDP growth.

– High level of defense consumption.

– Larger impact on lower social classes.

– Great impact on uncertainty which influences economic activity in the macro and micro levels.

Implications of TerrorImplications of Terror (Eckstein and Tsiddon (2003))(Eckstein and Tsiddon (2003))

• With high rates of terror, output, consumption, investment and exports decline significantly.

• In times of terror, non-durable consumption and GNP per capita reduced by about 3.2% annually, while exports and investments reduced by 14%.

• GDP could have been 12% higher.

GDP Growth and Unemployment GDP Growth and Unemployment RateRate

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GDP Growth Unemployment rateSource: CBS and BOI *BOI Forecast

Budget Framework TodayBudget Framework Today• Keeping the Public Expenditure under 47% of

GDP• What is the desirable rate of public expenditure?

Main services that we need to take into consideration: security, health care, education, etc.

• Decrease of the budgetary deficit to around 1%, so that the public sector debt would be about 60% of GDP.

Fiscal stability supports the financial stability, Fiscal stability supports the financial stability, and both set the ground for annual GDP and both set the ground for annual GDP

growth of 4-5% and moregrowth of 4-5% and more..

Monetary Policy, and Inflation and

Exchange Rate Evolution

Managing Monetary Policy : Managing Monetary Policy : Bank of Israel TargetsBank of Israel Targets

• Achieving price stability, adhering to inflation target (1-3%).

• Promoting financial stability.

• Banking Supervision: Supporting the stability and efficiency of the banking system

Developing the capital market in a Developing the capital market in a global economic atmosphere ensures global economic atmosphere ensures

efficiency in consumption, investments efficiency in consumption, investments and production.and production.

Short term interest rate

Monetary Policy in 2006 and 2007Monetary Policy in 2006 and 2007

• Inflation in the past 12 month was below target bound (-0.8%). Main impact factors: depreciation of the $ and decreasing of the gas prices in the past 6 month.

• Decrease of risk premium and default spreads of the Israeli economy.

• Current account surplus.

The Importance of Transparency and The Importance of Transparency and Moderation in Monetary Policy Moderation in Monetary Policy

ManagementManagement

• Policy steps should be moderate in order to prevent panic in markets. Keen decisions should be taken only in crisis times.

• Keeping policy transparent.

• Signaling agents in the markets regarding policy fundamentals.

Monetary policy and Inflation in Monetary policy and Inflation in 20072007::

Private forecasters: 2.0%.

Capital market: 1.4%.

The economic atmosphere enables BOI being at a low interest rate of 4%, while achieving prices and financial system stability.

Reforms

The Israeli Economy The Israeli Economy WeaknessesWeaknesses

• Financial markets:– Money markets are not at the world’s high

standards– High centralization, low level of

competition and efficiency in the banking system.

– Banks are the main suppliers of financial services – change had begun in 2000 prior to Bachar reform.

The Israeli Economy The Israeli Economy WeaknessesWeaknesses

• Labor market:– High poverty.– Low participation/employment rate.– Foreign workers.

• Education system.- low levels of basic knowledge: Need to reform

• Low productivity in low-tech sectors.

• Infrastructures:– Low urban development in peripheral areas.– Lack of public transportation and low quality of

roads in peripheral areas.

What needs to be doneWhat needs to be done??• Financial markets:

– Enhancement of efficiency, competition and financial instruments: Following the world.

• Labor market: – Active Labor Market Policies: US/UK examples– Reduction of foreign workers– Compliance with labor laws

• Infrastructure improvement.

• More reforms…”Doing Business” by the World Bank.