This document presents the macroeconomic staff forecast formulated by the Bank of Israel Research Department in October 2020 concerning the main macroeconomic variables—GDP, inflation, and the interest rate. The forecast includes two main scenarios: a scenario characterized by control over the development of morbidity, and a scenario characterized by less control over development of morbidity.[1]
In the greater-control scenario, GDP is expected to contract by 5 percent in 2020. In this scenario, further broad lockdowns or a significant shutdown of economic activity are not expected. Accordingly, growth in 2021 is expected to be relatively high—about 6.5 percent. However, the average level of activity will be about 5 percent lower than the pre-crisis trend. Inflation in the four quarters ending in the third quarter of 2021 is expected to be 0.3 percent, and for the year 2021 it is expected to be 0.6 percent. The broad unemployment rate[2] among those aged 15 and up (hereinafter “the unemployment rate”) is expected to average 17 percent of the labor force during the fourth quarter of 2020, and to decline gradually to 8 percent at the end of 2021. The government deficit is expected to be about 13 percent in 2020 and 8 percent in 2021, such that the debt to GDP ratio is expected to climb to 73 percent at the end of 2020 and to 76 percent in 2021.
In the lower-control scenario, GDP is expected to contract by 6.5 percent in 2020, and to grow by just 1.0 percent next year. Therefore, in such a scenario, the average level of activity will be about 11.5 percent lower than the pre-crisis trend. Inflation in the coming four quarters is expected to be -0.2 percent, and for the year 2021 it is expected to be 0.1 percent. The broad unemployment rate (aged 15+) is expected to be 20.2 percent during the fourth quarter of 2020 (lockdown period), and to decline to 13.9 percent at the end of 2021. The government deficit is expected to be about 13 percent in 2020 and 11 percent in 2021, such that the debt to GDP ratio will increase to 75 percent in 2020 and to 83 percent in 2021.
The Forecast
In this forecast, as in the recent forecasts published, special emphasis was placed on an industry analysis in order to understand the economic impact of the crisis and of the policy measures taken due to it. In particular, the forecast is based on an assessment regarding the shutdown of various industries as a result of government measures to fight the spread of the virus. In addition, the forecast is based on several indicators and models. The Bank’s DSGE (Dynamic Stochastic General Equilibrium) model developed in the Research Department—a structural model based on microeconomic foundations—which provides a framework for analyzing the forces that have an effect on the economy, was used to combine them into a coherent macroeconomic forecast.[3]
a. 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 by foreign investment houses. The assumptions regarding GDP, inflation, world trade, and the interest rate in advanced economies are similar to those that we used in the previous forecasts, with slight revisions based on developments and various scenarios.
In both scenarios, the forecast assumes that imports to the advanced economies will contract by 9 percent in 2020, and will return to growth of 7 percent in 2021. The forecast also assumes that GDP of the advanced economies will contract by 4.1 percent in 2020, and will increase by 5.7 percent in 2021. Inflation in the advanced economies is expected to be 0.3 percent in 2020 and 1.0 percent in 2021.
b. Real activity in Israel
The two scenarios have the same starting point at the end of the third quarter of 2020. The estimated volume of third-quarter inactivity (“the shutdown rate”) prior to the closure is 5–7 percent, and third-quarter growth is assumed to be higher than the assessment in the previous forecast (in both scenarios). The inactivity rate is calculated on the basis of an industry analysis, weighting information from the Central Bureau of Statistics flash survey (negative impact to revenue), credit card expenditures, labor force survey (labor input by industry), and judgement assessments regarding industries that are not covered by these indicators—partly on the basis of the industry’s sensitivity to social distancing. In both scenarios, there is a significant decline in activity at the start of the fourth quarter as a result of the lockdown imposed at the start of the holiday season, but the scenarios differ concerning the manner of exit from the lockdown and its implications. Both scenarios are based on the working assumption that a vaccine or treatment for the virus will be found in mid-2021 that will enable a return to economic routine without restrictions on economic activity. It should be emphasized that this is not a medical forecast, but a working assumption for the purposes of formulating an economic forecast and analysis.
In the control scenario, we assume that the development of morbidity during the fourth quarter will enable a relatively rapid exit from the closure. We also assume that later in the year, a COVID routine outline will be successfully implemented, such that morbidity will stabilize at a level that will enable relatively broad economic activity. Therefore, within this scenario, from the end of October 2020 until a vaccine is found, growth will recover gradually.
In the lower-control scenario, there is difficulty in designing and implementing a COVID routine outline. In such scenario, the morbidity level is unstable, and economic activity is periodically restricted (through government order or as a result of the public’s voluntary avoidance). Therefore, from now until a vaccine is found, there will be a number of morbidity waves that will be reflected in a reduction of economic activity.
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Table 1 Research Department Staff Forecast for 2020–2021 Control scenario and lower control scenario (rates of change, percent, unless stated otherwise)
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Control scenario |
Lower control scenario |
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Forecast for 2020 |
Forecast for 2021 |
Forecast for 2020 |
Forecast for 2021 |
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GDP |
-5.0 |
6.5 |
-6.5 |
1.0 |
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Private consumption |
-8.9 |
9.9 |
-10.5 |
4.9 |
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Fixed capital formation (excl. ships and aircraft) |
-7.7 |
3.9 |
-8.2 |
0.3 |
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Public consumption (excl. defense imports) |
7.1 |
0.9 |
7.1 |
1.2 |
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Exports (excl. diamonds and startups) |
-3.6 |
3.9 |
-4.4 |
1.3 |
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Civilian imports (excl. diamonds, ships, and aircraft) |
-8.0 |
6.5 |
-8.7 |
4.9 |
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Unemployment rate (25–64) (average for the year) |
4.2 |
6.9 |
4.5 |
9.4 |
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Employment rate (25–64) (average for the year) |
75.5 |
72.6 |
75.2 |
70.6 |
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Broad unemployment rate (15+) (Average for the year) |
15.7 |
10.0 |
16.6 |
16.7 |
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Broad unemployment rate – fourth quarter (15+) |
16.7 |
7.8 |
20.2 |
13.9 |
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Government deficit (percent of GDP) |
13 |
8 |
13 |
11 |
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Table 2 Control scenario and lower control scenario published on August 24, 2020 (rates of change, percent, unless stated otherwise) |
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2020 |
2021 |
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Current scenario |
Change from August |
Current scenario |
Change from August |
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-5.0 |
-0.5 |
6.5 |
0.5 |
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Private consumption |
-8.9 |
-1.3 |
9.9 |
1.1 |
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Fixed capital formation (excl. ships and aircraft) |
-7.7 |
-0.2 |
3.9 |
-0.4 |
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Public consumption (excl. defense imports) |
7.1 |
0.0 |
0.9 |
0.0 |
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Exports (excl. diamonds and startups) |
-3.6 |
0.5 |
3.9 |
-0.3 |
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Civilian imports (excl. diamonds, ships, and aircraft) |
-8.0 |
-0.4 |
6.5 |
-0.6 |
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Unemployment rate (25–64) (average for the year) |
4.2 |
-0.7 |
6.9 |
0.0 |
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Employment rate (25–64) (average for the year) |
75.5 |
0.6 |
72.6 |
0.0 |
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Broad unemployment rate (15+) (Average for the year) |
15.7 |
1.8 |
10.0 |
0.5 |
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Broad unemployment rate – fourth quarter (15+) |
16.7 |
5.1 |
7.8 |
0.0 |
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Table 3 Control scenario and lower-control scenario published on August 24, 2020 (rates of change, percent, unless stated otherwise) |
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2020 |
2021 |
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Current scenario |
Change from August |
Current scenario |
Change from August |
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GDP |
-6.5 |
0.5 |
1.0 |
-2.1 |
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Private consumption |
-10.5 |
0.0 |
4.9 |
-1.3 |
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Fixed capital formation (excl. ships and aircraft) |
-8.2 |
0.3 |
0.3 |
-0.6 |
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Public consumption (excl. defense imports) |
7.1 |
0.0 |
1.2 |
0.0 |
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Exports (excl. diamonds and startups) |
-4.4 |
2.3 |
1.3 |
-0.6 |
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Civilian imports (excl. diamonds, ships, and aircraft) |
-8.7 |
1.3 |
4.9 |
0.2 |
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Unemployment rate (25–64) (average for the year) |
4.5 |
-0.3 |
9.4 |
2.6 |
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Employment rate (25–64) (average for the year) |
75.2 |
0.3 |
70.6 |
-2.0 |
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Broad unemployment rate (15+) (Average for the year) |
16.6 |
2.7 |
16.7 |
7.2 |
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Broad unemployment rate – fourth quarter (15+) |
20.2 |
8.6 |
13.9 |
6.1 |
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c. Inflation and interest rates
In the control scenario, inflation in the next four quarters (ending in the third quarter of 2021) is expected to be 0.3 percent (Table 4), and inflation in 2021 is expected to be 0.6 percent. In the lower-control scenario, inflation in the next four quarters is expected to be -0.2 percent (Table 4), and inflation in 2021 is expected to be 0.1 percent.
The assessment of the path of inflation during the forecast period is impacted by a particularly high level of uncertainty. In particular, it is necessary to assess where the impact is greater, on the supply side or on the demand side. Our assessment is that the COVID crisis has had a more significant impact on the decline in demand than on the decline in supply, such that in total, inflation will decline. In accordance with this analysis, the inflation path in the control scenario is higher than in the lower- control scenario. This analysis is consistent with the decline in inflation during the second quarter of 2020, and with similar assessments worldwide.
Table 4 shows that the Bank of Israel Research Department’s range of inflation forecasts during the coming year is lower than the average of private forecasters. Expectations for the coming year derived from the capital market declined in recent weeks, and are now similar to the Research Department’s forecast for the lower-control scenario. Regarding the interest rate in one year, both the forecasters’ projections and the expectations derived from the capital market are within the range of the Research Department’s forecast.
In both scenarios, the Research Department’s assessment is that a year from now, the Bank of Israel’s interest rate will be between 0 and 0.1 percent (Table 4), similar to our assessment in the August forecast. However, should the situation worsen, and particularly if the lower-control scenario is realized, the Bank of Israel can operate a variety of tools, including the possibility of a further lowering of the interest rate, in accordance with developments.
The low interest rate supports the recovery of demand and the lowering of financing costs for businesses (insofar as credit will be available to them), and it is necessary in order to help the economy exit the crisis. Should further monetary accommodation be necessary, the Bank of Israel may expand or accelerate the use of existing or additional monetary policy tools. Despite the low pace of inflation in the coming year, the pace of inflation is expected to increase to its pre-crisis level thereafter, as long as demand recovers and the effect of the decline in energy prices and the appreciation of the shekel dissipate.
Table 4 |
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Inflation and interest rate forecasts for the coming year |
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(percent) |
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Bank of Israel Research Department |
Capital marketsa |
Private forecastersb |
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Inflation ratec |
-0.2–0.3 |
-0.3 |
0.4 |
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(range of forecasts) |
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(-0.4–0.7) |
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Interest rated |
0–0.1 |
0.1 |
0 |
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(range of forecasts) |
(-0.4–0.25) |
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a) Average expectations following the publication of the September CPI. Inflation expectations are seasonally adjusted. b) The forecasts published in the week following the publication of the September CPI. c) Inflation rate in the coming year. Research Department: in the four quarters ending in the third quarter of 2021. |
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d) The interest rate one year from now. (Research Department: in the third quarter of 2021.) Expectations derived from the capital market are based on the Telbor market. SOURCE: Bank of Israel. |
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d. Main risks to the forecast[4]
The Research Department’s staff forecast presents two scenarios that reflect reasonable boundaries—a scenario in which the scope of morbidity is controlled, and one in which the scope of morbidity is less controlled. The risks to the forecast are therefore more extreme developments in each of the two potential directions. Developing a vaccine more quickly or a more rapid recovery of global activity may lead to a more rapid increase in economic activity in Israel than is reflected in the control scenario. In contrast, a significant worsening of morbidity data, a delay in developing a vaccine, ineffectiveness of the lockdown, and an uncontrolled exit from the lockdown are risks that may lead to economic developments that have a more moderating effect than forecast as part of the lower-control scenario.
[1] These scenarios reflect a reasonable, but not absolute, range of the seriousness of the economic impact of the COVID pandemic. More pessimistic scenarios (a spillover into major closures as in the past, a worsening of financial stability, continuation of the crisis as a result of not finding a vaccine, and more) and more optimistic scenarios (finding a vaccine early, the ability to cross below the 7–8 percent inactivity benchmark during the crisis, a very rapid recovery after the crisis, and more) are certainly possible.
[2] The broad unemployment rate relates to those who are unemployed under the ordinary definition (those who have not worked, wanted to work, were available to work, and looked for work), employed people who were temporarily absent for an entire week for reasons having to do with COVID (including those on unpaid leave, public service workers on forced vacation, and the self-employed who did not work), and a surplus decline in the labor force (a decline in the participation rate that is beyond the trend).
[3] An explanation of the macroeconomic forecasts formulated by the Research Department, as well as a survey of the models upon which it is based, appear in Inflation Report number 31 (for the second quarter of 2010), Section 3c. 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.
[4] In view of the anomalous uncertainty in the forecast and the unusual volatility of the activity variables, the forecast is being published without the interest rate, inflation, and GDP fan charts.