Most analysts thought that the Bank of Israel would leave its interest rate unchanged in December at 0.75%, for the 4th consecutive month, but central bank Governor Stanley Fischer surprised with a 0.25% increase – to 1%. Following the decision, analysts' reactions varied from one end of the spectrum to the other – from a statement that the interest increase constituted a serious blow to the business sector, which has just begun to recover from the recession, to the opinion that recent signs of initial recovery justified the increase in interest, which still remains low and far below equilibrium.
In its press statement on the interest rate increase, the Bank of Israel gave three main reasons for the decision:
A concern about accelerating inflation: over the last 12 months, inflation was 2.9%, very close to the upper bound of the 1-3% annual inflation target, and the bank considers that in the months ahead, inflation could pass this upper bound (this is strange because most forecasts point to restrained inflation over the next 6 months). Thus higher interest is needed to maintain inflation within the target range.
Economic activity is beginning to revive: GDP in the 3rd quarter grew at an annualized rate of 2.2% and was the second consecutive quarter with positive growth (see the blog of 22.11.09 entitled "Everbody's growing"). This and other recent signs of revival show that interest can be increased without fear of compromising the revival. In any case, a 1% interest rate is still very low and can assist activity to continue expanding.
Signs of interest increases in other countries: though some central banks have increased interest in recent months, the US Federal Reserve and the European Central Bank still have not. However, the Bank of Israel claims that these central banks are making preparations to begin increasing their interest rates during 2010, for the same reasons that interest has already been raised in Israel.
There is no doubt that Governor Fischer received "backing" for his decision from the accelerated growth of exports in recent months, proof of an initial global revival, and from devaluation of the shekel of some 3% against the US$ over the past month: he obviously considers that the higher interest rate will not strengthen the shekel enough to alter the positive export trend.
Will the recent interest hike lead to further increases in the near future? This is unlikely, even though most analysts consider current interest to be too low. The Governor will certainly wait and see what happens with interest policy in the US and Europe: at the moment, the consensus is that the Fed will not begin to increase interest before the 2nd half of 2010.
After the recent increase, interest in Israel is now 0.75 percentage points above interest in the US. The Governor will not want this gap to widen much further.
Posted on the I-Biz blog on 22 November 2009
Nov 25, 2009
Nov 23, 2009
Everybody's growing
GDP in Israel grew by an annualized 2.2% in the 3rd quarter of 2009. As the media reacted, this is an impressive performance: the second consecutive quarterly increase after two quarters of negative growth, an accelerated increase compared to the previous quarter (where growth was revised up from 0.8% to 1%), and overall, a clear sign of Israel's recovery from the recession. But perhaps the most important economic news is that most industrialized economies showed positive growth in the 3rd quarter. As Professor Stanley Fisher, Governor of the Bank of Israel, has stated frequently, revival of the economy will only be assured when the global economy begins to revive.
Israel did not experience the fastest 3rd quarter growth: GDP in Korea, Japan, the US, Germany and Italy grew faster. Israel is also not the only industrialized country with two consecutive quarters of renewed growth to its credit: the Japanese, German and French economies also began growing again in the 2nd quarter of 2009.
What is certain is that the recession in Israel was much shorter than in practically all other industrialized countries, which experienced 4-5 consecutive quarters of negative growth compared to Israel's two (the one exception was Korea, with only one quarter of declining GDP). The two main industrialized economies still showing negative growth in the 3rd quarter of 2009 are the UK and Spain: for both, this is the 6th consecutive quarter of declining GDP.
The impressive nature of Israel's 3rd quarter growth performance is also reflected in the developments in the main GDP components which increased rapidly: private consumption – by an annualized 8.9% (following an 8.1% increase in the previous quarter, fixed capital investment – by 23.2%, and exports of goods and services – by 21.8% (following a 14.6% jump in the previous quarter).
The 2.2% increase in total GDP seems limited compared to these sharp increases in GDP components. The explanation is the parallel steep increase in imports of goods and services in the 3rd quarter – by 61.9%. This increase in imports is in itself an indicator of recovery, in an economy as dependent as Israel is on imports as an ingredient of growth.
Other indicators of activity in October (such as the Purchasing Managers' Index) show growth continuing in the early part of the 4th quarter. But there are still some major sectors where the latest data point to a long way to go to return to pre-recession levels: one example is industrial production which in September 2009 (the latest month for which data are available) was still more than 8% lower than in mid-2008.
So however impressive 3rd quarter GDP data look, the consensus is that the revival, in Israel and elsewhere, is still very much in its initial stages. It could take a long time before we can conclude that the global economy is finally "out of the woods".
Posted on the I-Biz blog on 22 November 2009
Israel did not experience the fastest 3rd quarter growth: GDP in Korea, Japan, the US, Germany and Italy grew faster. Israel is also not the only industrialized country with two consecutive quarters of renewed growth to its credit: the Japanese, German and French economies also began growing again in the 2nd quarter of 2009.
What is certain is that the recession in Israel was much shorter than in practically all other industrialized countries, which experienced 4-5 consecutive quarters of negative growth compared to Israel's two (the one exception was Korea, with only one quarter of declining GDP). The two main industrialized economies still showing negative growth in the 3rd quarter of 2009 are the UK and Spain: for both, this is the 6th consecutive quarter of declining GDP.
The impressive nature of Israel's 3rd quarter growth performance is also reflected in the developments in the main GDP components which increased rapidly: private consumption – by an annualized 8.9% (following an 8.1% increase in the previous quarter, fixed capital investment – by 23.2%, and exports of goods and services – by 21.8% (following a 14.6% jump in the previous quarter).
The 2.2% increase in total GDP seems limited compared to these sharp increases in GDP components. The explanation is the parallel steep increase in imports of goods and services in the 3rd quarter – by 61.9%. This increase in imports is in itself an indicator of recovery, in an economy as dependent as Israel is on imports as an ingredient of growth.
Other indicators of activity in October (such as the Purchasing Managers' Index) show growth continuing in the early part of the 4th quarter. But there are still some major sectors where the latest data point to a long way to go to return to pre-recession levels: one example is industrial production which in September 2009 (the latest month for which data are available) was still more than 8% lower than in mid-2008.
So however impressive 3rd quarter GDP data look, the consensus is that the revival, in Israel and elsewhere, is still very much in its initial stages. It could take a long time before we can conclude that the global economy is finally "out of the woods".
Posted on the I-Biz blog on 22 November 2009
May 18, 2009
Has inflation returned?
For four consecutive months – November 2008 to February 2009, there was negative inflation in Israel. All the analysts said: naturally, obviously, there's a recession developing which is causing inflation to decline. And then consumer prices increased by 0.5% in March while on 15 May, the Consumer Price Index (CPI) for April was published, showing a sharp 1% increase. Were the analysts wrong? Are there specific reasons for the strong April inflation or do the March-April consumer price increases indicate a new positive inflation trend?
The first point to make is that April inflation is traditionally high, because of seasonal factors. In the past five years (2004-2008), consumer prices increased by an average 0.9% in April. The seasonally adjusted increase in consumer prices in April 2009 was just 0.3%, compared to the 1% increase in the unadjusted index.
What are the main seasonal factors in April? One is seasonal increases in fruit and vegetable prices as new summer fruits come onto the market: in April 2009, the fruits and vegetables component of the CPI increased by 2%: in the previous three years (2006-2008), this component jumped by an average 4.4%.
Another seasonal component is clothing and footwear prices, which increased in April 2009 by 3.5%: in the years from 2000 to 2008, these prices jumped by an average 5.8 in April. Yet another seasonal element of the CPI in April is education, culture and entertainment prices: in April, these prices increased by 1.1%, identical to the average annual increase in this CPI component in the previous 4 years (2005-2008).
Besides these seasonal components, transportation prices increased by 3.3%, with a sharp 6.2% in the foreign travel sub-component (mainly as a result of the shekel devaluation in that month) and a 2.9% increase in the car purchase and maintenance sub-component (mainly as a result of the increase in fuel prices at the beginning of April).
But all this does not add up to a new positive inflationary trend, to cause concern to policy makers. In this respect, it is interesting to ask what the decision will be regarding the central bank interest rate, to be made at the end of May. The current rate of interest is 0.5%, set at the end of March. At the end of April, the Governor of the Bank of Israel decided to leave the rate unchanged, even though most analysts expected him to lower it further to 0.25%. The question now is whether Professor Stanley Fischer will again leave the rate unchanged, or – after two months of positive inflation - decide to increase it, in reaction to the inflation.
Given the clear indications of continuing recession, this is unlikely to happen. But the Governor might argue that the rate of interest is so low in any case, and a further reduction in the rate is unlikely, on its own, to make any difference to reviving economic activity. However, interest policy could be used (by raising the rate of interest) to cut off the possibility of increasing inflation.
In the context of this possibility, analysts argue that if the 2009-2010 State Budget, recently approved by the Government (see the I-Biz blog: A budget…at last) finally becomes law, it could lead to higher inflation for two main reasons: the tax increases built into the budget and the agreed-to 3% increase of government expenditure, instead of the original intention to increase expenditure by just 1.7%.
Who knows: it could well be that inflation, instead of turning out to be just a reaction to declining activity, could turn out to be a major topic of economic discussion in the months ahead.
The first point to make is that April inflation is traditionally high, because of seasonal factors. In the past five years (2004-2008), consumer prices increased by an average 0.9% in April. The seasonally adjusted increase in consumer prices in April 2009 was just 0.3%, compared to the 1% increase in the unadjusted index.
What are the main seasonal factors in April? One is seasonal increases in fruit and vegetable prices as new summer fruits come onto the market: in April 2009, the fruits and vegetables component of the CPI increased by 2%: in the previous three years (2006-2008), this component jumped by an average 4.4%.
Another seasonal component is clothing and footwear prices, which increased in April 2009 by 3.5%: in the years from 2000 to 2008, these prices jumped by an average 5.8 in April. Yet another seasonal element of the CPI in April is education, culture and entertainment prices: in April, these prices increased by 1.1%, identical to the average annual increase in this CPI component in the previous 4 years (2005-2008).
Besides these seasonal components, transportation prices increased by 3.3%, with a sharp 6.2% in the foreign travel sub-component (mainly as a result of the shekel devaluation in that month) and a 2.9% increase in the car purchase and maintenance sub-component (mainly as a result of the increase in fuel prices at the beginning of April).
But all this does not add up to a new positive inflationary trend, to cause concern to policy makers. In this respect, it is interesting to ask what the decision will be regarding the central bank interest rate, to be made at the end of May. The current rate of interest is 0.5%, set at the end of March. At the end of April, the Governor of the Bank of Israel decided to leave the rate unchanged, even though most analysts expected him to lower it further to 0.25%. The question now is whether Professor Stanley Fischer will again leave the rate unchanged, or – after two months of positive inflation - decide to increase it, in reaction to the inflation.
Given the clear indications of continuing recession, this is unlikely to happen. But the Governor might argue that the rate of interest is so low in any case, and a further reduction in the rate is unlikely, on its own, to make any difference to reviving economic activity. However, interest policy could be used (by raising the rate of interest) to cut off the possibility of increasing inflation.
In the context of this possibility, analysts argue that if the 2009-2010 State Budget, recently approved by the Government (see the I-Biz blog: A budget…at last) finally becomes law, it could lead to higher inflation for two main reasons: the tax increases built into the budget and the agreed-to 3% increase of government expenditure, instead of the original intention to increase expenditure by just 1.7%.
Who knows: it could well be that inflation, instead of turning out to be just a reaction to declining activity, could turn out to be a major topic of economic discussion in the months ahead.
A budget... at last
It's not all over yet, but at last – and at least – the government has approved (on 13 May) the new-fangled 2-year State Budget for 2009-2010. It's not over because the budget still has to past muster with the Knesset Finance Committee – always a difficult hurdle – and has to be approved into law by a plenary session of the Knesset, another not simple task. But the first step in the process has been taken and this is good news. Or is it?
The government approval of the budget was preceded by an incredible amount of political wrangling, with threats to bring the government down issued pretty much on a daily basis, "if this or that is not included in or excluded from the budget".
There were also major problems with the management of this initial stage of the budget approval process. A week before government approval, the Ministry of Finance published a list of draconic measures to be included in the budget, which immediately raised storms of indignation, both in the general public and among politicians from all parties, not only from the opposition. The main claim was that the measures would mostly adversely affect the lower-income population.
It is extremely unlikely that Prime Minister (PM) Binyamin Netanyahu was unaware of these proposed measures before their publication by the Finance Ministry, and yet immediately after they were announced and in reaction to the public and political criticism, the PM scolded the Ministry, demanding that it take another look at the measures and scrub most of them.
Another problem is with the question of who is responsible for the approved budget proposal. The Minister of Finance, Yuval Steinitz, has little experience with economic matters and from the outset of this new government, the PM stated that in addition to his being PM, he would also act as a kind of Super-Minister for Long-term Economic Strategy (he was the Finance Minister in 2003-2005 – with not inconsiderable success at the job, so at least he has experience with economic affairs). There are accusations that the recently approved budget is mostly not the work of the Finance Minister and his staff (as it would normally be) but rather the work of the PM and his chief economic adviser, who were accused of bypassing the Finance Ministry.
One potentially serious outcome of this internal struggle was the resignation of the head of the Finance Ministry's Budget Department, immediately after the budget was approved by the government: he stated that he could not take any responsibility for the approved budget (or was not given responsibility for it) and therefore felt that he had no choice but to resign.
And then there is the question of who won the political battle over the budget. The main argument was over the expenditure increase. The PM and his Likud party wanted the increase to be limited to 1.7% - the Labor Party, a coalition partner, argued for a much larger increase, in line with other governments around the world who have adopted large government expenditure increases to help their economies emerge from the recession. The compromise in the approved budget was a 3% expenditure increase both in 2009 and in 2010. As usually happens in Israel, after the compromise was reached, all sides claimed victory.
Does the government-approved budget match the campaign promises of the PM? The answer is no: among other things, the PM promised tax cuts as a way of reviving the economy, but in fact the budget calls for tax increases (VAT is to increase from 15.5% to 16.5% and VAT is to be levied on fruits and vegetables for the first time in Israel's history).
The government obviously felt it had no choice here: the recession has brought about a drastic decline in tax revenues, while the plans of the Finance Ministry to lower government expenditure in 2009 and 2010 will only partially materialize: this is particularly true of the defense budget, by far Israel's largest budget at the ministry level, where the compromise in the approved budget was to lower expenditure by just 25% of the expenditure cut that the Finance Ministry proposed (it turns out that the Minister of Defense is the leader of the Labor Party, which pushed for the far larger increase in overall government expenditure).
The outcome of all this is that the expected budget deficit is 6% of GDP in 2009 and 5.5% in 2010, a recession-level deficit, whose financing will call for a dramatic increase of government debt, both domestic and foreign.
So is the government approval of the budget good news? Only time will tell if the new budget contributes to reviving the economy. Certainly the lower income groups can be satisfied – almost all of the draconic measures initially proposed by the Ministry of Finance have been abandoned.
The government approval of the budget was preceded by an incredible amount of political wrangling, with threats to bring the government down issued pretty much on a daily basis, "if this or that is not included in or excluded from the budget".
There were also major problems with the management of this initial stage of the budget approval process. A week before government approval, the Ministry of Finance published a list of draconic measures to be included in the budget, which immediately raised storms of indignation, both in the general public and among politicians from all parties, not only from the opposition. The main claim was that the measures would mostly adversely affect the lower-income population.
It is extremely unlikely that Prime Minister (PM) Binyamin Netanyahu was unaware of these proposed measures before their publication by the Finance Ministry, and yet immediately after they were announced and in reaction to the public and political criticism, the PM scolded the Ministry, demanding that it take another look at the measures and scrub most of them.
Another problem is with the question of who is responsible for the approved budget proposal. The Minister of Finance, Yuval Steinitz, has little experience with economic matters and from the outset of this new government, the PM stated that in addition to his being PM, he would also act as a kind of Super-Minister for Long-term Economic Strategy (he was the Finance Minister in 2003-2005 – with not inconsiderable success at the job, so at least he has experience with economic affairs). There are accusations that the recently approved budget is mostly not the work of the Finance Minister and his staff (as it would normally be) but rather the work of the PM and his chief economic adviser, who were accused of bypassing the Finance Ministry.
One potentially serious outcome of this internal struggle was the resignation of the head of the Finance Ministry's Budget Department, immediately after the budget was approved by the government: he stated that he could not take any responsibility for the approved budget (or was not given responsibility for it) and therefore felt that he had no choice but to resign.
And then there is the question of who won the political battle over the budget. The main argument was over the expenditure increase. The PM and his Likud party wanted the increase to be limited to 1.7% - the Labor Party, a coalition partner, argued for a much larger increase, in line with other governments around the world who have adopted large government expenditure increases to help their economies emerge from the recession. The compromise in the approved budget was a 3% expenditure increase both in 2009 and in 2010. As usually happens in Israel, after the compromise was reached, all sides claimed victory.
Does the government-approved budget match the campaign promises of the PM? The answer is no: among other things, the PM promised tax cuts as a way of reviving the economy, but in fact the budget calls for tax increases (VAT is to increase from 15.5% to 16.5% and VAT is to be levied on fruits and vegetables for the first time in Israel's history).
The government obviously felt it had no choice here: the recession has brought about a drastic decline in tax revenues, while the plans of the Finance Ministry to lower government expenditure in 2009 and 2010 will only partially materialize: this is particularly true of the defense budget, by far Israel's largest budget at the ministry level, where the compromise in the approved budget was to lower expenditure by just 25% of the expenditure cut that the Finance Ministry proposed (it turns out that the Minister of Defense is the leader of the Labor Party, which pushed for the far larger increase in overall government expenditure).
The outcome of all this is that the expected budget deficit is 6% of GDP in 2009 and 5.5% in 2010, a recession-level deficit, whose financing will call for a dramatic increase of government debt, both domestic and foreign.
So is the government approval of the budget good news? Only time will tell if the new budget contributes to reviving the economy. Certainly the lower income groups can be satisfied – almost all of the draconic measures initially proposed by the Ministry of Finance have been abandoned.
Mar 1, 2009
Is 2009 a lost year?
It was really only a matter of time before the developing recession in Israel showed up in the ultimate macro-economic data – GDP and unemployment: in most other developed economies, data have already been published showing negative GDP growth and increasing unemployment, with dire forecasts for 2009. But no such evidence was available in Israel – until 4th quarter 2008 data for GDP and unemployment were published in the last week of February. What light do these data shed on the Israeli economy during 2009?
Here are the dry facts: GDP declined by an annualized 0.5% in the final quarter of 2008, while 3rd quarter growth was revised down to 0.9%, compared to an earlier estimate of 2.3%. Growth in the complete 2nd half of 2008 was reduced to 1.1%, compared to 4.8% in the 1st half of the year. The 4th quarter decline in GDP is the first since 2002, when the Israeli economy was in recession.
Results for business sector product, more sensitive to cyclical movements in the economy than GDP, were even worse: negative growth of 1.2% in Q4/08, with the 3rd quarter increase revised down to just 0.5% (an earlier estimate for this quarter was a 1.9% increase). Business sector product growth has now been lower than GDP growth for two consecutive quarters, a clear indication of a brewing recession.
Now unemployment: the unemployment rate increased to 6.3% in Q4/08 (based on the Labor Force Survey for that quarter, the most comprehensive labor market dataset in Israel) from 6% in the previous quarter: this is the first meaningful quarterly increase in unemployment since 2003, when the economy was still in recession (up to mid-year).
This initial increase in unemployment was not paralleled by a decrease in total employment (even though marginal employment indicators are already showing a decline in the demand for labor), but there were nevertheless significant declines in unemployment in Q4/08 in commerce, industry and business services.
In addition, there was a sharp decline in full-time employment and a parallel steep increase in part-time employment: this is classic textbook labor market behavior in the initial stages of a recession, with employers cutting costs by transferring workers from full-time to part-time employment. The Israeli economic press has been full recently of reports about companies – particularly in the high-tech sector – moving over to a 4-day week.
What does all this tell us about the prospects for 2009? The Bank of Israel, prior to the publication of these new data, had already forecast a 0.2% decline in 2009 GDP. However, soon after that, the Economist in London published its own forecast for Israel – a 0.9% increase in 2009 GDP. After the 0.5% decline in 4th quarter GDP was published, expectations were voiced that in the opening quarter of 2009 the decline of GDP could accelerate to 4%.
The truth is that no-one really knows the answers to the two most important economic questions at present: a) when will the recovery begin; b) how fast will it be once it begins. Regarding the US economy, we have heard answers to the first question ranging from Ben Bernanke, Chairman of the US Federal Reserve – that the recovery could start by the end of 2009, to Warren Buffett, who recently claimed (after his holding company Berkshire-Hathaway suffered a 96% drop in profits in Q4/08) that the recovery might not even start before 2011. Another still unanswered question is whether stock exchanges around the world have reached their low points, and whether it is now worthwhile purchasing shares. Everyone agrees that if and when the recovery begins (both in real economies and in capital markets), it will be exceedingly slow.
The chances are therefore that 2009 will be a lost year for economies around the world – for Israel as well: low or negative growth, contracting world trade, burgeoning budget deficits are only a few of the characteristics of a lost economic year. Everyone also agrees that the current crisis has brought/will bring about fundamental changes in the "rules of the economic/financial game" that determine behavior in the global economy. It seems now that the speed of the recovery, once it begins, will depend very much on the extent to which the new rules are accepted and adhered to.
Here are the dry facts: GDP declined by an annualized 0.5% in the final quarter of 2008, while 3rd quarter growth was revised down to 0.9%, compared to an earlier estimate of 2.3%. Growth in the complete 2nd half of 2008 was reduced to 1.1%, compared to 4.8% in the 1st half of the year. The 4th quarter decline in GDP is the first since 2002, when the Israeli economy was in recession.
Results for business sector product, more sensitive to cyclical movements in the economy than GDP, were even worse: negative growth of 1.2% in Q4/08, with the 3rd quarter increase revised down to just 0.5% (an earlier estimate for this quarter was a 1.9% increase). Business sector product growth has now been lower than GDP growth for two consecutive quarters, a clear indication of a brewing recession.
Now unemployment: the unemployment rate increased to 6.3% in Q4/08 (based on the Labor Force Survey for that quarter, the most comprehensive labor market dataset in Israel) from 6% in the previous quarter: this is the first meaningful quarterly increase in unemployment since 2003, when the economy was still in recession (up to mid-year).
This initial increase in unemployment was not paralleled by a decrease in total employment (even though marginal employment indicators are already showing a decline in the demand for labor), but there were nevertheless significant declines in unemployment in Q4/08 in commerce, industry and business services.
In addition, there was a sharp decline in full-time employment and a parallel steep increase in part-time employment: this is classic textbook labor market behavior in the initial stages of a recession, with employers cutting costs by transferring workers from full-time to part-time employment. The Israeli economic press has been full recently of reports about companies – particularly in the high-tech sector – moving over to a 4-day week.
What does all this tell us about the prospects for 2009? The Bank of Israel, prior to the publication of these new data, had already forecast a 0.2% decline in 2009 GDP. However, soon after that, the Economist in London published its own forecast for Israel – a 0.9% increase in 2009 GDP. After the 0.5% decline in 4th quarter GDP was published, expectations were voiced that in the opening quarter of 2009 the decline of GDP could accelerate to 4%.
The truth is that no-one really knows the answers to the two most important economic questions at present: a) when will the recovery begin; b) how fast will it be once it begins. Regarding the US economy, we have heard answers to the first question ranging from Ben Bernanke, Chairman of the US Federal Reserve – that the recovery could start by the end of 2009, to Warren Buffett, who recently claimed (after his holding company Berkshire-Hathaway suffered a 96% drop in profits in Q4/08) that the recovery might not even start before 2011. Another still unanswered question is whether stock exchanges around the world have reached their low points, and whether it is now worthwhile purchasing shares. Everyone agrees that if and when the recovery begins (both in real economies and in capital markets), it will be exceedingly slow.
The chances are therefore that 2009 will be a lost year for economies around the world – for Israel as well: low or negative growth, contracting world trade, burgeoning budget deficits are only a few of the characteristics of a lost economic year. Everyone also agrees that the current crisis has brought/will bring about fundamental changes in the "rules of the economic/financial game" that determine behavior in the global economy. It seems now that the speed of the recovery, once it begins, will depend very much on the extent to which the new rules are accepted and adhered to.
Feb 12, 2009
The election and the economy
The February 10 general election was extremely inconclusive. The 2 leading parties, Kadima and Likud, won a practically equal number of seats in the new Knesset, with each one's share less than 25% of the total 120 Knesset seats. There is no certainty as to which of the leaders of these parties w
First things first: the 2009 State Budget. Knesset approval of this budget (generally by 31 December of the previous year) was postponed unt
Based on what we know at present, the party leader asked to form a government w
Is there a problem with this? If the approval of any budget proposal is delayed, the government is allowed to spend each month during the delay period 1/12 of the total budget expenditure of the previous year, so there is a de facto budget. But the new budget is supposed to reflect the government's economic policy for the current year, so a delay in approving the new budget means a delay in implementing necessary economic policy. This creates uncertainty, particularly unwanted when the underlying economic situation is bad and in itself a source of great uncertainty, as it certainly is at present.
This brings us to the declared economic policy of each of the two party leaders vying to head the new government, both recognizing the fact that the Israeli economy is clearly on its way to recession or is already in recession. One major proof of this is a steep decline in tax revenues that began in early 2008 and is forecast to continue in 2009. About one thing there is complete consensus regarding the 2009 budget – the budget deficit is going to be much higher this year, as a direct result of the decline in tax revenues: it was already higher in 2008 (2.1% of GDP) than in 2007, when the budget was balanced.
Back to declared economic policy: in its election campaign, the Likud announced that if it came to power, it intended to reduce tax rates to help the economy exit the recession. This planned policy is strongly opposed by both the Ministry of Finance and the Bank of Israel – if the 2009 budget deficit is already going to be much higher at existing tax rates, they argue, lowering tax rates w
Given the severity of its current economic situation and the deep uncertainty it has created,
Jan 27, 2009
The interest gap is closing
With the US Federal Reserve interest rate down to 0-0.25%, there is little room left for maneuver for interest rate policy in the US, to help revive the American economy. In Israel, on the other hand, with interest holding at 1.75%, there was still a way to go. However, on 26 January, the Bank of Israel announced its decision to reduce interest further – to 1%, thus narrowing the interest gap between the US and Israel. Will it be narrowed further? We will have to wait a month to see.
This is the 6th interest reduction in Israel since September 2008, when interest stood at 4.25%: at the same time, the US Fed interest rate was a much lower 2%. The recent process of interest rate reduction has therefore been much more dramatic in Israel than in the US: since September, interest in Israel has fallen by 3.25% (from 4.25% to the current 1%) while in the US, the reduction has been 1.75-2%. So the narrowing of the interest gap between Israel and the US has been going on now for several months.
The concern in Israel – and the rationale for the interest rate reductions – has been the same as in the US: the slowdown in the economy and the strong possibility that the slowdown will turn into a recession (a period of negative GDP growth). This is already accepted in the US but now it is also accepted by the Bank of Israel. In July 2008, the Bank published a forecast of 3.4% growth in 2009. This was reduced to 3.1% in August, to 2.7% in October and to 1.5% in November.
Just one day before its most recent interest rate decision, the Bank published is latest 2009 growth forecast according to which the Israeli economy will be in recession in 2009, with negative growth of -0.2% (see our blog of 14 January – "Growth forecasts for 2009 keep getting reduced"). The performance of the economy in 2009 may well turn out to be even worse than this.
Will the interest rate reductions work, helping to revive the Israeli economy? In the press statement that accompanied the reduction of interest to 1%, the Bank of Israel complained – not for the first time – that interest rate reductions by the central bank since September have not been followed by similar reductions implemented by the commercial banking sector and that the commercial banks have not eased up on the credit crunch.
This of course is what has to happen if the reduction in interest is to work. The central bank cannot force the commercial banks to lower interest when it lowers interest, but in the past, commercial interest has generally followed central bank interest closely. The commercial banks argue that since interest payments constitute a major part of their income, lowering interest too much could jeopardize their stability.
However much the Bank of Israel would want to avoid this possibility (especially in view of the collapse of major banks in the US and elsewhere), the banks' argument is not regarded as satisfactory by the Bank of Israel. The counter argument is that it is in the commercial banks' own interest to do everything possible to help revive the economy.
Central bank Governor Stanley Fischer announced that if the commercial banks do not come through of their own volition and lower interest, he will have no choice but to implement (perhaps regulatory) measures to make them do so. Everyone is now waiting to see what these measures could be.
This is the 6th interest reduction in Israel since September 2008, when interest stood at 4.25%: at the same time, the US Fed interest rate was a much lower 2%. The recent process of interest rate reduction has therefore been much more dramatic in Israel than in the US: since September, interest in Israel has fallen by 3.25% (from 4.25% to the current 1%) while in the US, the reduction has been 1.75-2%. So the narrowing of the interest gap between Israel and the US has been going on now for several months.
The concern in Israel – and the rationale for the interest rate reductions – has been the same as in the US: the slowdown in the economy and the strong possibility that the slowdown will turn into a recession (a period of negative GDP growth). This is already accepted in the US but now it is also accepted by the Bank of Israel. In July 2008, the Bank published a forecast of 3.4% growth in 2009. This was reduced to 3.1% in August, to 2.7% in October and to 1.5% in November.
Just one day before its most recent interest rate decision, the Bank published is latest 2009 growth forecast according to which the Israeli economy will be in recession in 2009, with negative growth of -0.2% (see our blog of 14 January – "Growth forecasts for 2009 keep getting reduced"). The performance of the economy in 2009 may well turn out to be even worse than this.
Will the interest rate reductions work, helping to revive the Israeli economy? In the press statement that accompanied the reduction of interest to 1%, the Bank of Israel complained – not for the first time – that interest rate reductions by the central bank since September have not been followed by similar reductions implemented by the commercial banking sector and that the commercial banks have not eased up on the credit crunch.
This of course is what has to happen if the reduction in interest is to work. The central bank cannot force the commercial banks to lower interest when it lowers interest, but in the past, commercial interest has generally followed central bank interest closely. The commercial banks argue that since interest payments constitute a major part of their income, lowering interest too much could jeopardize their stability.
However much the Bank of Israel would want to avoid this possibility (especially in view of the collapse of major banks in the US and elsewhere), the banks' argument is not regarded as satisfactory by the Bank of Israel. The counter argument is that it is in the commercial banks' own interest to do everything possible to help revive the economy.
Central bank Governor Stanley Fischer announced that if the commercial banks do not come through of their own volition and lower interest, he will have no choice but to implement (perhaps regulatory) measures to make them do so. Everyone is now waiting to see what these measures could be.
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