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.
May 18, 2009
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.
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