Has the Israeli economy reached the end of the recession, or at least, a turning point? Anyone who wishes to believe so can point to yesterday's report of the rise in the Bank of Israel's State of the Economy Index, which rose in June for the first time in a year, by 0.2%. For its part, the Bank of Israel has tried to damp down the optimism, saying that it was matter of one month's figures, and that we would have to wait and see how the index developed over the next few months.
For the central bank, the question whether recovery has started is not an academic one. On the contrary, the answer to that question will determine, in large part, the direction of monetary policy in the coming months. The Bank of Israel has been debating, and not in a whisper, the question of exiting the expansionist policy it has conducted since the end of 2008. If it turns out that the economy is starting to emerge from recession, the bank will have to decide how to pull back from the policy that has led to a 60% rise in the money supply in the past 12 months. This means defining a course of interest rate rises that, on the one hand, will prevent a rise in inflation, while, on the other hand, not choking off growth. However, if the State of the Economy Index represents only a temporary and unimportant phenomenon, these tough decisions can be deferred.
It must be taken into account that the rise in the index mainly reflected rises in the export and import components, while the employment and output components remained negative. This too is a reason to restrain expectations, and to confront an economic reality of recession, unemployment, and local demand that still refuses to recover.
Another point that the optimists have to take into account is that the State of the Economy Index is not a lead indicator. It tells us nothing about the future. The index that the Bank of Israel publishes only provides a picture of the state of the economy at a certain moment, without being able to predict future developments. All that can be said, therefore, is that, on the whole, there was a tiny rise in economic activity in June, particularly in foreign trade, but nothing can be concluded from that about the future.
Nevertheless, despite all these reservations, it is hard to exaggerate the significance of the figures released yesterday. First of all because, when all's said and done, this is the first rise after months of declines. Secondly, because the central bank had to revise the May figure upwards, from -0.5% to -0.3%, so that there is something of an improving trend in the monthly index figures.
There is also something else worth examining, because it validates the optimistic feelings. The meaning of the State of the Economy Index figures can be tested more accurately if the long-term growth rate is discounted. In this way, it is possible to ask a more relevant question: how far do developments for the month to which the index relates diverge from existing trends? The findings are fairly clear. Until January, the figure kept falling, indicating that the decline in activity was accelerating. By contrast, since February this year, the picture has changed; the index figure is higher than what would have been obtained from the long-term growth line, and the gap has broadened each month. That is a far clearer sign of a turning point. When this finds expression in the overall index figure, the recovery will become official, and the Bank of Israel will reach the parting of the ways.
Published by Globes [online], Israel business news - www.globes.co.il - on July 20, 2009
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