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

The Macroeconomic Picture

Real GDP per capitaReal GDP per capitaIsrael vs. USAIsrael vs. USA

Source: BEA, PWT, OECD, BOI

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901922

1929

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Israeli GDP per capita (left scale)

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

Running an Economy Under Running an Economy Under TerrorTerror

• In 2000-03) terror has become a part of every day life in Israel.– A continuous impact on GDP growth.

– High level of defense consumption.

– Larger impact on the weaker segment of the population.

– 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)

• When the rate of terror incidents is high, output, consumption, investment and exports decline significantly.

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

• GDP could have been 12% higher.

GDP Growth and the Unemployment GDP Growth and the Unemployment RateRate

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GDP growth Unemployment rate

Source: CBS and BOI *BOI Forecast

The Budget Framework TodayThe Budget Framework Today• Keeping 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 financial stability, and Fiscal stability supports financial stability, and both set the ground for annual GDP growth both set the ground for annual GDP growth

of 4-5% and moreof 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 the efficiency of the banking system

Developing the capital market in a Developing the capital market in a global economic environment ensures global economic environment 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 (-0.8%). Main impact factors: depreciation of the $ and the falling of fuel prices in the past 6 month.

• Decrease of sovereign risk premium.

• 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. Harsh decisions should be taken only in crisis times.

• Keeping policy transparent.

• Signaling agents in the markets regarding policy fundamentals.

Monetary Policy and Expected Monetary Policy and Expected Inflation in 2007Inflation in 2007::

Private forecasters: 2.0%.

Capital market: 1.4%.

The economic atmosphere enables the BoI to operate at a low interest rate of 4%, while achieving the inflation target 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 rate of 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.