Fiscal Rules Uri Gabai National Economic Council Prime Minister Office 5 May 2009

1. Fiscal Rules Uri Gabai National Economic Council Prime Minister Office 5 May 2009

2. Government Debt Israel’s General Government Debt(% of GDP) Source: Bank of Israel, Apr. 2009

3. Government Debt: Israel vs. OECD General Government Debt, OECD countries (% of GDP, 2007) Source: OECD Economic Outlook 83 & Bank of Israel, Apr. 2008

4. Fiscal Rules in Israel – Brief History • 1992: Deficit targetsset • 1992-2004: Poor adherence to fiscal rules, though created a “psychological effect” • 2003 Economic Plan included: • Expenditure ceilings of 1% per annum , later changed to 1.7% + “Boxes” • Declining deficit path (from 4% down to 1% GDP) • 2008 Budget Fiscal Rules: • 1.7% Expenditure ceiling • 1% Deficit Target

5. National Economic Council’s Model

6. Current Fiscal Rules – why revise? On one hand, • High success in fiscal constraining and debt reduction On the other hand, • Rules are not derived from long-term explicit targets • Rules haven’t been fully implemented – “boxes”… • Rigidity facing changing reality • Danger of overshooting in the decline of G/Y Invites pressures, risk of uncontrolled change, inability to provide public goods necessary for growth

7. Background for Setting Targets – International Comparison, 2008 • Simple Averages • * Data for 2006

8. Fiscal goals for the next decade • Decreasing the debt to GDP ratio to OECD standards. Specifically: Lowering the debt ratio to 60% of GDP by 2020 • Supplying public goods adequately • Subject to the above – moderate decrease in the tax burden

9. The model in a nutshell The expenditure ceiling will be determined each year by a clear formula – the product of two factors: • GDP’s growth environment • Distance from the target debt/GDP ratio

10. The model – basic assumptions First Assumption: In steady state –expenditures should growproportionallyto the GDP growth This will enable supporting the growing demand for public goods Hence, the expenditure ceiling should be “related” to the GDP growth rate

11. The model – basic assumptions Second Assumption: expenditures should be either mildly countercyclical or acyclical The main countercyclical effect is achieved by letting taxes behave as “automatic stabilizers” Hence, expenditures should be a function of the growth environment

12. The model – basic assumptions Third Assumption: The strength of the relation between expenditures and GDP growth should depend on the “distance” from the debt target Specifically, The rule should become less restrictive (i.e. closer to the growth environment) as we approach the debt target and vice versa

13. The model expenditure ceiling “restraint parameter” - Distance from target Growth environment X Which target? Debt/GDP ratio – 60% Which Growth? Multi-year average Expenditure ceiling Growth Environment restraint parameter

14. The model expenditure ceiling “restraint parameter” - Distance from target Growth environment X Which target? Debt/GDP ratio – 60% Which Growth? Multi-year average Expenditure ceiling Growth Environment restraint parameter

15. Restraint parameter - The distance in % from the debt target restraint parameter = 1 - Debt / GDP target current Debt/GDP ratio

16. Restraint parameter - The distance in % from the debt target restraint parameter = 1 - Debt / GDP target current Debt/GDP ratio 16

17. Restraint parameter - The distance in % from the debt target restraint parameter = 1 - Debt / GDP target current Debt/GDP ratio 17

18. The model expenditure ceiling “restraint parameter” - Distance from target Growth environment X Which target? Debt/GDP ratio – 60% Which Growth? Multi average growth Expenditure ceiling Growth Environment restraint parameter

19. Growth environment • The Israeli economy is very dynamic – the variance of growth rates is relatively high So, how can we determine the growth environment? • On the one hand, we should consider the growth rate of the long term – multi year average. • On the other hand, some weight should be given to recent growth rates, as they may better represent the “current” growth level.

20. Determining the Growth environment Growth environment - average of the growth rates in: Long term growth Short term growth Average of growth rates in the last 10 years* Average of growth rates in current and previous year *Updates every 5 years

21. Computing the expenditure ceiling The formula: growth environment restraint parameter Expenditure ceiling X = For 2009: 4.2x 0.67 =2.8 For 2010: 2.6 x 0.70=1.8

22. expenditure ceiling - the following years

23. cyclicality of the fiscal rule – which growth to take? GDP growth exp. ceiling Long and short term growth Long term growth only Hypothetical growth path 2008-2020

24. Fiscal Policy - summary • Determining the expenditure ceiling each year according to the formula presented here • Maintaining low deficit – 1% over the business cycle 3. tax policy will be determined subject to these policy tools 4. Determining escape clauses for extreme situations

25. Thank you!

26. GDP growth rates, Israel and selected countries Selected Countries: Australia, Belgium, Canada, France, Germany, Italy, Japan, NZ, Spain, Sweden, UK, USA 26

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