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

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

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

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4 Fiscal Rules in Israel – Brief History 1992: Deficit targets set 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

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5 National Economic Councils Model

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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 havent 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

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

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8 Fiscal goals for the next decade 1. Decreasing the debt to GDP ratio to OECD standards. Specifically: Lowering the debt ratio to 60% of GDP by 2020 2. Supplying public goods adequately 3. Subject to the above – moderate decrease in the tax burden

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

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10 The model – basic assumptions First Assumption: In steady state – expenditures should grow proportionally to 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

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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

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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

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

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

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

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

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

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

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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.

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

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

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expenditure ceiling - the following years

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

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24 Fiscal Policy - summary 1.Determining the expenditure ceiling each year according to the formula presented here 2.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

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25 Thank you!

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

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