In many respects, Prime Minister Benjamin Netanyahu's decision to double the deficit target to 3% of GDP in 2013 should not be considered a surprise. First, the Bank of Israel has set a target of 2.5% in its talks with the Ministry of Finance, and all macroeconomic analyses converged around this figure.
Add the scenes of Saturday's riot in Tel Aviv's financial district, and the fact that Netanyahu is not known for outstanding decision-making under pressure, the addition of NIS 4 billion to the deficit target beyond the Bank of Israel's recommendation, could have been anticipated. The question is what the additional money will be used for: will it be added to the defense budget, with a few budget crumbs for social purposes? Or is this an attempt to avoid raising direct taxes on high income-earners?
Another question that should be asked is what is Netanyahu's spiel, his maneuvering room, in the event that the budget assumptions do not materialize, and the deficit balloons even larger than planned. Were Netanyahu to heed the Bank of Israel's advice, and build a budget with a deficit target of 2.5% of GDP, he would still have given himself maneuvering room of 0.5% of GDP in case of a recession and extreme volatility in the global economy.
In the end, the government has been struggling to formulate a consistent budget policy, even if the markets have not reacted to this reality. A greater than expected fall in revenues, a jump in defense spending, or anything else that will force the government to make decisions about budget items, are liable to cause a radical change in the internal fiscal forecasts, and force Netanyahu to actually make decisions.
To grasp the thin line that Netanyahu is walking on fiscal policy, it is necessary to refer to the Bank of Israel's decision on Monday to cut the interest rate for July to 2.25%. To tell the truth, it is not yet clear whether Netanyahu found it proper to update Governor of the Bank of Israel Prof. Stanley Fischer, before the latter decided to lower the interest rate.
The Bank of Israel cited several reasons for its interest rate decision, beginning with the global economic climate, its assessment that there are currently no significant inflationary pressures, and the possibility that leading central banks around the world will launch a new round of monetary expansion.
In effect, when the latest interest rate cut takes effect, the interest rate will have been cut by 100 basis points over 13 months. In May 2011, the Bank of Israel raised the interest rate by 25 basis points. It argued that the decision to raise the interest rate to 3.25% was consistent with bringing the interest rate "to a more normal range intended to position inflation firmly within the target range, and to support the further recovery of economic activity, while maintaining financial stability."
The difference between that announcement and the latest interest rate decision shows just how far Fischer has gone in concluding that "normalcy" has not arrived. He has reverted to the days when he thought that it was necessary to take the global economic downturn into account, before trying to restore a "normal interest rate". It can be stated that 3% GDP growth is economic policy's last line of defense against a possible recession. This is exactly the scenario that Netanyahu is now trying to ignore.
Europe pressed self-destruct button long ago
In some respects, Fischer is different from other central bankers. He is one of the last central bankers to enjoy maneuvering room in monetary policy, and he can still use the interest rate as a tool for protecting economic activity and jobs. As long as developments in the Israeli and global economies stay under control, he can deal with the storm with the tools in his possession. From this aspect, yesterday's interest rate cut is the closest that the Bank of Israel can offer at the moment as business as usual. The Bank of Israel hopes that the coming months will stay this way. Even if GDP grows by just 3%, ordinary tools will suffice to deal with the situation.
The problem is that no one can promise Fischer that the world will continue to be managed in a routine way. European leadership, beginning with German Chancellor Angela Merkel, pressed the self-destruct button for the Eurozone long ago, and seems to be in no hurry to reverse the decision. A financial storm in a few weeks or months is a possible result, which will annul any normalcy and routine in the global economy.
At that point, Fischer's move will meet Netanyahu's. If a global financial storm erupts, then Fischer will have to admit that internal monetary decisions are simply not enough, and Netanyahu will find himself facing a serious fiscal crisis.
Published by Globes [online], Israel business news - www.globes-online.com - on June 26, 2012
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