Flug lays out her guideline for next gov’t to lower cost of living

Rivlin calls on the Knesset and the incoming government to formulate and pass the budget as quickly as possible.

March 31, 2015 13:06
3 minute read.
Karnit Flug and Reuven Rivlin

BOI Governor Karnit Flug presents annual report to President Reuven Rivlin. (photo credit: HAIM ZACH/GPO)


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Bank of Israel Gov. Karnit Flug on Tuesday laid out a series of recommendations for the upcoming government, including approaches on how to lower the cost of living and housing, easing poverty, and fiscal guidelines.

Presenting the BoI’s annual report in the capital, Flug said the top priorities for the government should include reducing bureaucracy, increasing competition, boosting housing supply and sticking to fiscal targets.

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Flug noted that the cost of living is slightly higher than would be expected given the country’s GDP per capita, but that costs in some sectors were outliers. Food, beverage, cars and hotels are relatively expensive in Israel, while furniture, equipment and clothing are relatively cheap. Flug urged the government to introduce more competition by lowering barriers to both imports and new local players in overpriced sectors, but warned against quick fixes through VAT exemptions.

Many politicians, including most recently Prime Minister Benjamin Netanyahu, have urged exemptions from the 18% VAT for basic items. Flug argued that one of the strengths of Israel’s VAT system is that there are few exemptions, and creating differential VAT for certain products could backfire, creating new bureaucracy, distorting the market as producers try to exempt their products, and sliding down a slippery slope as interest groups try to elbow their way into exempt status.

BoI Research Department director Prof. Nathan Sussman presented a portion of the report showing that negative income tax, sometimes called the earned income tax credit, is a better tool for alleviating poverty than increasing the minimum wage. On Monday, the Histadrut labor federation and the Manufacturers Association of Israel agreed on an increase to the minimum wage to go into effect at the end of 2017, beyond one planned for Wednesday and two more planned by the start of 2017.

Worker productivity, Flug noted, is lower in Israel than in most OECD countries, in part because the country does not invest enough in infrastructure such as transport, ports, electricity and water.

Flug cited an International Monetary Fund study demonstrating that every additional percentage point of GDP directed toward investments raises overall output by 0.4% that year and 1.5% four years later. Low productivity is linked to low wages.

Chapters of the BoI Annual Report released in recent weeks outlined how Israel’s transportation plans consistently run into walls, go over budget and fail to meet timetables for completion.

Regarding the state budget, Flug said the incoming government will face a challenge, given limits on the deficit and spending increases on the one hand, and Israel’s relatively low expenditure on welfare, health and education. Moshe Kahlon, the likely finance minister, told The Jerusalem Post during the election campaign that he would be willing to increase the size of government beyond the current spending limits. Based on current projections, Kahlon will have to find some NIS 10 billion in spending cuts and revenue increases to hit both goals in 2016.

Flug’s last statements were largely directed at Kahlon, who has put reforming the banking system near the top of his economic agenda. While Kahlon and Flug both believe in increased competition, Flug has a more regulatory approach stemming from concern over the stability of the banking system. She showed that in the past few years, reforms have pushed the majority of financial resources in Israel outside the banking system.

Flug emphasized significant steps BoI took to reduce fees and increase competition in banks, led by Supervisor of Banks David Zaken. Asked if she opposes a Kahlon initiative to take the bank supervisor regulatory position outside of BoI, Flug said that such experiments in other countries, such as the UK, did not end well.

She said that introducing credit unions and other forms of financial institutions was a positive step, but emphasized that stringent capital standards were necessary to avoid weak institutions, which could lead to a financial crisis.

Finally, in regards to monetary policy, Flug reiterated that unconventional policies (such as quantitative easing and negative interest rates) were an option that the bank would not hesitate to use in the right circumstances. The bank, however, was not itching to deploy such tools, she said.

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