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BANK OF ISRAEL
Office of the Spokesperson and Economic Information
June 28, 2012
Press Release
Remarks by Dr. Karnit Flug, Deputy Governor of the Bank of Israel at the Caesarea Forum
session “The State Budget in Light of the Social Protest”
The theme of this session—The State Budget in Light of the Social Protest—hints at the tremendous
challenge facing the government. On the one hand, the fiscal situation is particularly challenging in the
face of the global economic storm, which calls for added caution in budget planning; on the other hand,
we are experiencing a revival of the social protest which is perceived not to have achieved the results
that were hoped for last summer. This feeling exists in spite of the fact that the government, in a
genuine effort to respond to the public's problems and feelings of frustration, established the
Trajtenberg Committee (of which I had the honor of being a member)—which presented far-reaching
recommendations on a wide variety of issues (while remaining within the budget framework)—and
decided to adopt a large proportion of those recommendations. Later on, I will try to expand on the
tension existing between the need to maintain fiscal discipline and the importance of implementing the
Committee's recommendations.
I will focus on the following issues:
1) The effect of the uncertainty implicit in macroeconomic forecasts.
2) The importance of limiting the deficit to 2.5 percent of GDP by maintaining the expenditure
rule and by raising taxes, in order to further reduce the debt/GDP ratio.
3) Dealing with excessive government commitments (each year) relative to the expenditure rule.
4) The importance of implementing the Trajtenberg recommendations in education, particularly
free compulsory education for 3-4 year olds.
The working group that prepared the document presented at this Forum provided an accurate
macroeconomic picture and a reasonable forecast, as well as describing the future paths of budget
aggregates derived from this forecast, and provided an accurate analysis of the spectrum of policy
options available to the government. My main comment regarding the macroeconomic forecast and the
budget policy derived from it is the lack of reference to the exceptionally high level of uncertainty
surrounding the forecast. In the current situation, when levels of volatility are at historic highs and
there are numerous possible outcomes for the situation in the eurozone, there is a need to discuss
various scenarios or at least the level of uncertainty surrounding the forecasts. The level of uncertainty,
and the possibility of a European crisis that will affect us as well, is also a factor in the determination of
optimal policy. First, the budget planning for 2013 must take this possibility into account. Second, the
discussion of intermediate-term alternatives should also relate to the uncertainty surrounding the
potential growth path.
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The group presented a range of alternatives for policy in 2013, which define the parameters of the
issues and help in identifying their problematic nature. I would choose a middle alternative that
provides the appropriate balance between the various considerations concerning the level of the deficit,
expenditure and taxes.
In view of the high level of uncertainty in the macroeconomic environment (particularly in the short
run but also regarding potential growth in the longer run), it is even more important to define a budget
ceiling that will ensure a renewed downward trend in the debt to GDP ratio, even if only at a
moderate rate. A deficit of around 2.5 percent of GDP, which will gradually decline to 1.5 percent
over a period of about four years, will achieve this. It is worthwhile mentioning that the low budget
deficit in 2008, and the prolonged downward trend in the debt to GDP ratio preceding it, created the
confidence in budget policy that facilitated the raising of the deficit during the crisis in 2009 (through
automatic stabilizers), which contrasted with the situation in 2001–03 which required us to cut the
budget in the midst of a recession.
The presentation pointed to the relatively low level of non-defense public expenditure (excluding
interest) in international terms and the effect this has on the quality of public services, and in turn on
inequality and growth. The expenditure rule adopted by the government, together with the path of
defense expenditure according to the Brodet framework, should enable non-defense expenditure to
grow somewhat faster than GDP and will make it possible to improve the level of non-defense services,
in particular education, even if only gradually. However, it is important to find a way to prevent the
accumulation of commitments that significantly exceed what is possible according to the fiscal
rule, as occurred this year due to the wage agreements and the expenditure on infrastructure, defense,
education, etc., which makes it difficult for the government to maintain the expenditure rule (even
though it allows for expenditure to grow each year).
Given the current expenditure situation and the recognition of the need to ensure a declining debt, and
therefore a deficit that gradually declines to 1.5 percent of GDP, an increase in taxes is called for. As
pointed out, our problem is a large structural deficit which prevents the reduction in the debt to GDP
ratio even if the economy grows at a reasonable rate. Therefore, given that expenditure will grow
according to the expenditure rule, an increase in taxes (both direct and indirect) is needed in order to
converge to a debt to GDP ratio of about 60 percent by the end of the decade. It is important that the tax
hikes ensure an increase in tax revenues over time rather than just a one-time increase, since the
problem of the deficit is structural and not primarily the result of the slowdown in economic activity
that we are currently experiencing.
With regard to the theme of the session—”The Budget in Light of the Social Protest”—it is worth
mentioning the extent to which last summer's protests influenced the budget's order of priorities.
Although the government adopted most of the Trajtenberg Committee's recommendations regarding
social services, and particularly education, the question of their implementation, according to the
recommended timetable, is still up in the air, primarily due to the large accumulation of budget
commitments that the government has taken on for coming years and the inability to cut the
defense budget in order to free up resources to cover those commitments. I hope that the
government will succeed in adjusting the order of priorities in a way that will enable the
implementation of the recommendations, while staying within the expenditure limit.
With respect to social services, the Trajtenberg Committee focused on expanding and improving
education services for young children. This was the correct thing to do in my opinion, in view of the
fact that high-quality educational services for young children not only have an effect on the economic
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situation of young families, they also have an effect on social gaps and the potential for growth. An
improvement in the quality of education has added importance in a country whose growth strategy
during the last two decades was based on its relative advantage in knowledge and human capital.
In this context, the recommendation to condition education for 3-4 year olds on the employment of the
parents is problematic. It is important to mention that the recommendation of the Trajtenberg
Committee on this issue viewed education for this age group as part of universal education and focused
on educational and developmental investment as a tool for reducing social gaps and providing a solid
base for the development of children, both cognitively and emotionally Studies have shown that early
intervention, particularly in the case of poor families, has a particularly high return with respect to
future outcomes, particularly in the labor market. In view of the high rates of poverty among singleearner families, it would be wrong both socially and economically not to provide a high-quality
education to the children in these families.
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