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Abstract

This document presents the macroeconomic staff forecast formulated by the Bank of Israel Research Department in January 2023[1] concerning the main macroeconomic variables—GDP, inflation, and the interest rate.

 

According to the forecast, GDP is expected to grow by 2.8 percent in 2023, and by 3.5 percent in 2024.  The inflation rate in the coming four quarters (ending in the fourth quarter of 2023) is expected to be 3.0 percent. The inflation rate in 2024 is expected to be 2.0 percent.  According to the forecast, the monetary interest rate is expected to average 4.0 percent in the fourth quarter of 2023.

 

 

The Forecast

The Bank of Israel Research Department compiles a staff forecast of macroeconomic developments on a quarterly basis. The staff forecast is based on several models, various data sources, and assessments based on economists’ judgment. The Bank’s DSGE (Dynamic Stochastic General Equilibrium) model developed in the Research Department—a structural model based on microeconomic foundations—plays a primary role in formulating the macroeconomic forecast.[2] The model provides a framework for analyzing the forces that have an effect on the economy, and allows information from various sources to be combined into a macroeconomic forecast of real and nominal variables, with an internally consistent “economic story”.

 

  1. The global environment

Our assessments of expected developments in the global economy are based mainly on projections by international institutions (the International Monetary Fund and the OECD) and foreign investment houses.  Their growth forecasts for the advanced economies were revised downward, mainly for 2023.  Accordingly, we assume that GDP growth in the advanced economies will be 0.1 percent in 2023 (compared with 0.4 percent in the previous (October) forecast), and 1.4 percent in 2024. The forecast for growth in world trade was revised upward to 3.0 percent in 2023 (compared with 2.5 in the previous forecast) and 3.8 percent in 2024, in view of the trend of easing delays in the supply chains and the decline in shipping costs.  The inflation forecasts for the advanced economies were revised slightly upward, and we assume that inflation in those economies will be 3.3 percent in 2023 (compared with 2.9 percent in the previous forecast) and 2.6 percent in 2024.  The increase in the inflation forecast was accompanied by an upward revision of the global interest rate forecast, such that the average interest rate in the advanced economies is expected to rise to 3.8 at the end of 2023 (compared with 2.4 percent in the previous forecast), but it is expected to decline to 2.9 percent at the end of 2024.  In contrast, the price of Brent crude oil declined to about $83 per barrel at the end of December, compared with $86 at the time of the previous forecast.

 

  1. Real activity in Israel

GDP is expected to increase by 2.8 percent in 2023 and 3.5 percent in 2024 (Table 1).  National Accounts data published since the previous forecast (for the period ending in the third quarter of 2022) were slightly higher than expected.  Therefore, the GDP level remains higher than the precrisis trend line.  However, it is expected to decline slightly to below the trend line later on. The expected slowdown in growth is due to an expected moderation in the growth of world trade (and therefore of Israeli exports), as well as an increase in the real interest rate in Israel within the forecast period.  The forecast regarding growth in 2022 was revised slightly upward due to the effect of final third quarter data.

 

At the forecast’s starting point, the labor market is tight, with a higher employment rate in the primary working ages and a slightly higher unemployment rate than before the COVID-19 crisis.  Within the forecast period, our assessment is that the labor market will remain tight, but will gradually return to the typical precrisis rates.  In particular, we forecast that the employment rate among the primary working ages will decline to an average of 77.4 percent in 2024, and the unemployment rate will increase to an average of 4.0 percent in the same year.

 

Regarding the State budget, our assessment is that the deficit within the forecast period will be lower than the deficit ceiling set out in the law. On the revenue side, our assessment is that the tax burden in 2023–24 will decline relative to 2022, and will be similar to that of 2021.  On the expenditure side, our assessment is that the government programs derived from the coalition agreements and the wage agreements that will be signed during 2023 will sharply increase public expenditure during the forecast period. However, we assume operations with an interim budget until approval of a budget in the first four months of 2023 that will create fiscal restraint.  Under these assessments, the deficit is expected to be at least 1.8 percent of GDP in 2023, and 2.1 percent of GDP in 2024. Debt will stabilize at 62 percent of GDP in 2023, and will decline to 61 percent of GDP in 2024.  However, the forecast is based on the assumption that budgetary expenditure will increase by only some of the assumed costs of the coalition agreements, and that wage increments in the expected agreements in the public sector will be moderate.  If the fiscal expansion is greater, inflation, the debt to GDP ratio, and yields in the capital market are expected to be higher than the predictions in the forecast.

 

 

 

Table 1

Research Department Staff Forecast for 2022–2024

(rates of change, percenta, unless stated otherwise)

 

2021

Forecast for 2022

Change from the October forecast

Forecast for 2023

Change from the  October forecast

Forecast for 2024

GDP

8.6

6.3

0.3

2.8

-0.2

3.5

Private consumption

11.1

7.0

-1.0

4.0

0.5

4.5

Fixed capital formation (excl. ships and aircraft)

12.2

9.0

1.0

3.0

0.0

4.0

Public consumption (excl. defense imports)

3.7

1.0

-3.0

3.5

-0.5

3.0

Exports (excl. diamonds and startups)

11.8

10.5

2.5

2.0

-0.5

2.5

Civilian imports (excl. diamonds, ships, and aircraft)

18.2

11.5

-1.0

4.0

0.5

5.5

GDP deviation from the precrisis trend (percent)

-1.4

0.7

0.2

-0.5

0.0

-0.9

Unemployment rate (average for the year, age 25–64)

4.6

3.2

0.1

4.0

0.5

4.0

Employment rate (average for the year, ages 25–64)

75.7

78.6

-0.1

77.5

-0.4

77.4

Government deficit (percent of GDP)

4.4

-0.3

-0.6

1.8

0.8

2.1

Debt to GDP ratio (percent)

68

62

-3.0

62

-1.0

61

Inflation (percent)b

2.5

5.2

0.6

3.0

0.5

2.0

a In the forecast of National Accounts components, the rate of change is rounded to the nearest half percentage point.

b The average of the Consumer Price Index in the last quarter of the year compared with the average in the last quarter of the previous year.

 

 

  1. Inflation and interest rates

According to our assessment, inflation in the next four quarters (ending in the fourth quarter of 2023) is expected to be 3.0 percent (compared with 2.5 percent in the previous forecast) (Table 2(. Inflation in 2024 is expected to be 2.0 percent.  The inflation rate is expected to slow during the forecast period due to more moderate demand, under the influence of restraining monetary policy in Israel and abroad, but also due to the continued moderation of supply-side pressures.  The upward revision of the inflation forecast for 2023 was mainly influenced by the depreciation of the shekel in terms of the nominal effective exchange rate, and by the upward revision of our assessments regarding the wage agreements expected in the public sector.  In contrast, our assessment is that the recent decline in oil prices will partly offset the effects of the exchange rate and wages.

 

The interest rate is expected average 4.0 percent in the fourth quarter of 2023 (Table 2).  Within the forecast range, we expect that the Bank of Israel interest rate will increase by 0.5 percentage points beyond our assessment in the previous forecast, to 4 percent at the end of 2023, and that this will help inflation converge to the midpoint of the target range. This assessment reflects a deepening of monetary restraint with an increase in the interest rate from its current level, in view of the upward revision of the inflation expectation and the high level of activity.

 

Table 2 shows that the Research Department’s staff forecast regarding inflation is higher than the average of the private forecasters’ projections[3] and expectations derived from the capital market, and that the interest rate forecast is similar to expectations derived from the capital market and slightly higher than the average of the private forecasters’ projections.

 

 


Table 2

Inflation forecast for the coming year and interest rate forecast for one year from now

(percent)
 

Bank of Israel Research Department

Capital marketsa

Private forecastersb

Inflation ratec

3.0

2.6

2.7 (2.2–3.5)

(range of forecasts)

 

 

 

Interest rated

4.0

4.0

3.7

(range of forecasts)

    

(2.75–4.0)

a) Inflation expectations are seasonally adjusted (As of December 29, 2022).

b) The average of forecasts published following the publication of the Consumer Price Index for December.

c) Inflation rate in the coming year. Research Department: in the four quarters ending in the fourth quarter of 2023.

d) The interest rate one year from now. (Research Department: average interest rate in the fourth quarter of 2023.) Expectations derived from the capital market are based on the Telbor market (as of December 29, 2022).

SOURCE: Bank of Israel.

 

 

 

 

  1. Main risks to the forecast

 

The risks to the forecast can be divided into global and domestic risks.  The global risks to the forecast include a slower-than-expected moderation of inflation abroad and inflation becoming more persistent in view of apparent pressures to increase wages, mainly in the US where the labor market remains tight.  A colder-than-expected winter, mainly in Europe, may again accelerate energy prices and have an upward effect on expected inflation and a downward effect on activity.  Easing the COVID-19 policy in China is expected to increase global activity and world trade, but also to increase demand for energy products and commodities, which would lead to inflation that is higher than our assessment in this forecast. Continued fighting in Ukraine is included in the base forecast.  The end of the fighting during the forecast period may moderate energy and commodity prices, accelerate activity, and lead to a lower inflation rate than our assessment.  In contrast, a worsening of the conflict may have a negative impact on energy and commodity prices and on economic activity, mainly in Europe.

 

Among the domestic risks, the wage agreements that are expected to be signed in the public sector contribute to some increase in the inflation rate in the base forecast.  The more generous those wage agreements are, the greater the risk of increases in the inflation rate, the interest rate, and unemployment, and of a decline in the growth rate.

 

There are currently no COVID-19-associated restrictions that harm economic activity, but a full return of incoming tourism also requires continued quiet in the political-security sphere.

 

[1]  The forecast was presented to the Bank of Israel Monetary Committee on January 1, 2023, prior to the decision on the interest rate made on January 2, 2023.

[2] A Discussion Paper on the DSGE model is available on the Bank of Israel website, under the title: “MOISE: A DSGE Model for the Israeli Economy,” Discussion Paper No. 2012.06.

[3] The average of the forecasters’ projections of expected inflation in 2023 as presented in Table 2 is calculated as the December 2023 index relative to the December 2022 index.  If the average of the forecasters’ inflation expectations are calculated based on their average monthly forecasts for the coming year, similar to the Research Department’s forecast as presented in the Table (fourth quarter average for 2023 compared with the fourth quarter average of 2022), they generate a similar expected inflation rate—2.9 percent.